## _cr1569 ## Source details **Canonical URL:** [_cr1569](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1569.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1569.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1569.pdf.json) --- ### Executive summary and program purpose - Ukraine requests a four-year Extended Arrangement (EFF) of SDR 12.348 billion (900 percent of quota; about US$17.5 billion). - Program purpose: restore stability and lay the basis for robust medium-term growth; respond to balance of payments pressures and adjustment needs that exceeded what the two-year SBA could deliver. - Extended arrangement provides broader and deeper reforms over a longer horizon and more financing time, building on the existing macroeconomic program. ### Core policy pillars - Securing financial stability: - Strong monetary policy framework to restore price stability. - Exchange rate flexibility to cushion against external shocks. - Comprehensive banking strategy: bank recapitalization, reduction of related party lending, resolution of impaired assets. - Strengthening public finances: - Expenditure-led adjustment to support fiscal consolidation. - Energy sector reforms and a debt operation to reduce fiscal imbalances and achieve public debt sustainability with high probability. - Revamp social protection schemes to protect the poorest and alleviate social costs. - Advancing structural reforms: - Governance reforms including anti-corruption and judicial measures. - Deregulation and tax administration reforms. - State-owned enterprise (SOE) reforms to improve corporate governance and reduce fiscal risks. - Naftogaz restructuring and broader energy sector reforms to increase energy efficiency and foster energy independence. ### Financing strategy and identified financing - Total financing package envisaged: around US$40 billion over 2015–18. - IMF support: - SDR 12.348 billion total access under EFF (about US$17.5 billion). - Frontloaded gross disbursements of SDR 7.092 billion (about US$10 billion) in 2015; SDR 1.915 billion (about US$2.7 billion) of the first disbursement for budget support. - Additional SDR 5.256 billion (about US$7.5 billion) over remainder of program, subject to successful implementation. - International donor commitments so far: US$7.2 billion (including US$1.5 billion under SBA, US$5.1 billion new budget support, US$0.6 billion multilateral support for gas payments). - Swap agreement in process to activate CNY 15 billion (about US$2.4 billion) with the People’s Bank of China. - Debt operation objectives: - Generate about US$15 billion during the program period. - Bring public and publicly guaranteed debt/GDP ratio below 71 percent of GDP by 2020. - Keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent annually) in 2019–2025. ### Risks and mitigation - Program risks described as "exceptionally high" due to: - Weak state of the Ukrainian economy. - Presence of vested interests opposed to reforms. - Ongoing conflict in the East and risk of intensification. - Mitigants: - Strong, bold, and frontloaded policy actions. - Significant external financial support. - Authorities’ steadfast policy implementation and resolution of the conflict would materially strengthen stabilization and growth prospects. ### Recent economic developments and key indicators - Output and employment: - GDP contracted by 6.9 percent in 2014. - GDP contracted by 5.3 percent in 2014:Q3. - GDP projected to contract by about 5½ percent in 2015. - Unemployment reached 8.9 percent as of end-September 2014, up from 7 percent a year earlier; projected to rise to 11.5 percent in 2015 from 10.5 percent at end-2014. - Inflation and exchange rate: - Inflation reached 24.9 percent at end-2014; reached 25 percent at end-2014; year-on-year headline inflation 28.5 percent in January 2015; y-o-y core inflation 26.1 percent. - Program projection: inflation about 27 percent in 2015; single digits by late 2016; around 5 percent over the medium term. - Hryvnia movements: lost nearly half of its value by end-December 2014 relative to a year ago; fell to around UAH 24–25/US$1 after NBU halted FX auctions on February 5; reached about UAH 29/US$1 on February 23; program exchange rate used in TMU: 15.7686 Hryvnia per U.S. dollar (set as of December 31, 2014). - Reserves and balance of payments: - Official reserves fell to US$6.4 billion at end-January 2015. - Program reserve strengthening targets: strengthen reserves to around US$18.3 billion (66 percent of the IMF composite reserve metric) at end-2015 and US$35.2 billion (about 113 percent of the metric) at end-2018; reserve target of US$26.7 billion (end of the SBA, 2016:Q1) expected to be reached by 2017:Q3. - Financing gap (2015–18): about US$40 billion (equivalent to 31¼ percent of estimated 2014 GDP). - 2015 financing gap: US$21.4 billion composed of Reserve build-up: US$10.8 billion; Underlying BOP gap: US$10.6 billion. ### Macroeconomic outlook and key projections - Growth: - Real GDP: -6.9 percent in 2014; contracting by about -5½ percent in 2015; recovery in 2016 with GDP projected to rise by 2 percent; reach potential by 2018 with growth around 4 percent by 2018. - Deep recession in 2014–15 of more than 12 percent; real GDP expected to surpass pre-crisis level only by 2019. - Projection assumes loss of economic capacity in eastern regions contributing over 2 percentage points to 2015 GDP decline. - Inflation: - Projected to rise to about 27 percent in 2015; recede in 2016; stabilize to around 5 percent over the medium term. - External account: - Current account deficit expected to narrow to 1.4 percent of GDP from 4.8 percent of GDP as REER depreciates cumulatively by 35 percent in 2014–15. - Exports declined about 14½ percent in 2014; exports to Russia dropped by some 34 percent in 2014. - Russia accounts for about 18 percent of exports; EU at 31½ percent. - External debt and reserves: - External debt: close to 100 percent in 2014; peak at 158 percent of GDP in 2015; decline to 115 percent of GDP by end-2020. - Public and publicly guaranteed debt projected to peak at 94 percent of GDP in 2015 then decline to below 71 percent of GDP in 2020 with debt operation. - Sovereign market re-access delayed to late 2017. - Under assumptions, reserves would strengthen to almost 100 percent of the Fund’s composite metric by end-2017. - Debt service and Fund repayment: - With EFF, repayment period extended through 2028; total repurchases during 2017–19 reduced from US$12.2 billion (SBA) to US$4.9 billion (EFF). - Repayment to the Fund over next five years would peak at 7.6 percent of reserves in 2018. - Outstanding credit to the Fund expected to peak at about 17.0 percent of GDP, or 54 percent of gross reserves, by the end of the arrangement in early 2019. - Debt service to the Fund as a ratio of exports of goods and services would peak at 3.5 percent in 2018. ### Banking sector stress, recapitalization, and related-party lending - Banking sector indicators and stress: - By mid-February 2015, banking system lost about 27 percent of deposits since January 2014 peak (equivalent to more than 12 percent of GDP). - NPLs rose from 12.9 percent of total loans at end-December 2013 to 19 percent at end-December 2014. - Return on assets: -4.1 percent at end-2014. - Large NBU liquidity support reached about 9 percent of total system liabilities as of mid-February 2015. - Aggregate CAR as of end-January 2015: 13.8 percent (down from 15.9 percent at end-June). - Recapitalization and resolution: - Cost of bank restructuring in 2014–15 estimated at 9¼ percent of GDP (upward revision from SBA estimate). - Program includes a buffer of nearly 4 percent of GDP in public funds for bank recapitalization and restructuring. - Recapitalization timelines: - Group 1 banks (nine large banks): credible plans and minimum 25 percent reduction in capital shortages by end-June 2015; failure leads to regulatory constraints or resolution. - Group 2 banks (next 20): recapitalization plans to be completed by end-February 2015. - Other banks: NBU stepped up resolution; 41 banks resolved through the DGF as of end-February 2015. - Revised recapitalization agreement: solvent banks may meet minimum CAR of 5 percent as of end-January 2016 and gradually reach 10 percent no later than end-December 2018. - Related-party lending reforms and unwinding schedule: - Prior action: legislative amendment introducing unlimited liability for shareholders holding 10 percent or more on losses from related-party lending. - Banks to report related party exposure: top 10 banks by end-May 2015; next 10 by end-July 2015; remaining banks by end-September 2015. - Prudential review of top 10 banks’ related party exposure to be completed by end-September 2015; NBU notification of discrepancies by end-July 2015 (structural benchmark). - Top 10 banks to submit unwinding action plans by end-October 2015 and agree with NBU by end-November 2015. - Unwinding plans to include quarterly schedules and minimum first payments/reductions of no less than 5 percent of excess loans to insiders. - Asset recovery and forensic audits: - Two pilot forensic audits of failed banks to be launched; terms of reference and tenders scheduled (e.g., TOR by end-February 2015; tender initiated by end-April 2015; launch by end-June 2015). ### Monetary policy, exchange rate, and NBU reforms - Monetary actions: - NBU increased policy rates multiple times: August +250 basis points; November +150 basis points (main rate) and +50–100 basis for longer deposits; early February +550 basis points to 19.5 percent; later increased main policy rate to 30 percent (increase by 1050 basis points) during exchange market episode. - Program anchored by very tight monetary policy to reduce FX demand; base and broad money growth negative in real terms. - NBU to set main policy rate positive in real terms on a 12–18 month forward-looking basis. - Exchange rate and FX measures: - Authorities maintain a flexible exchange rate regime; NBU will not sell FX except for central government needs and critical energy imports factored into the program. - NBU tightened administrative restrictions and capital controls (e.g., export surrender requirement to 75 percent; reduced limit for individuals’ FX purchases; banned transfers abroad of proceeds from OTC securities sales and dividend repatriation for such securities). - Authorities introduced a temporary import surcharge (exemptions for energy and pharmaceuticals) intended to be removed by end-2015. - Plan for gradual removal of exchange restrictions and capital controls to be prepared by May 15, 2015 (conditioned on stability and reserves). - Institutional and safeguards reforms: - Draft legislative amendments to the NBU Law to address governance, autonomy, and safeguards; parliamentary approval structural benchmark: end-April 2015. - NBU organizational and communication revamp; move toward inflation targeting once conditions and institutions permit. - IMF safeguards assessment (August 2014) identified deficiencies; authorities taking actions to strengthen internal controls; NBU to provide assurance reports and external audit management letters per reporting schedule. ### Fiscal framework, 2015 budget, and consolidation - 2014 fiscal outcomes: - Cash budget deficit for 2014 estimated at 4.6 percent of GDP (lower than target 5.8 percent). - Combined general government and Naftogaz deficit in 2014: 10.3 percent of GDP (Naftogaz deficit 5.7 percent of GDP). - 2015 budget and supplementary measures: - 2015 budget adopted targeting deficit of UAH 65 billion (3½ percent of GDP); amended supplementary budget prior action targeting UAH 78.2 billion general government deficit. - 2015 combined deficit: 7.4 percent of GDP (general government deficit of 4¼ percent of GDP and Naftogaz deficit of 3.1 percent of GDP). - 2015 budget eliminates coal-mining subsidies equivalent to 0.6 percent of GDP in 2014; reduces budgetary employment by 3 percent; freezes pensions during most of 2015; other pension and wage measures described. - Medium-term fiscal trajectory: - Primary balance of combined general government and Naftogaz: deficit of 6.9 percent of GDP in 2014 to surplus of 1.6 percent of GDP in 2017. - Combined deficit reduced to 2.6 percent of GDP by 2018 (general government deficit 2.6 percent of GDP and Naftogaz deficit zero by 2017). - Public and publicly guaranteed debt projected to peak at 94 percent of GDP in 2015 then decline to below 71 percent by 2020 with debt operation. - Consolidation composition (Percent of GDP): - Revenue measures total: 3.3 - Simplification of taxes and elimination of distortive taxes -0.5 - Eliminate foreign exchange sales tax for noncash transactions and increase for the cash transactions -0.3 - Eliminate small taxes and reform of the single tax -0.1 - Permanent revenue-raising measures 2.3 (detailed line items summing to 2.3) - Temporary measures 1.5 - Expenditure measures total: -4.1 - Maintain nominal wage bill at 2014 level (except military): -0.8 - Pension short-term measures: -2.3 - Reduction in subsidies to SOEs including coal industry: -1.1 - Other: -0.1; increase in energy subsidies to households while improving targeting: 0.3 - 2015 social protection: - Social assistance spending to reach 4.1 percent of GDP in 2015 (increase of 30 percent from 2014). - Unemployment benefit spending to rise by 15 percent. - IDP spending to increase six-fold in 2015, reaching about 1/4 percent of GDP. - Consolidation and retargeting of energy-related social assistance toward GMI over medium term. ### Energy sector reforms and Naftogaz measures - Naftogaz deficit and targets: - Naftogaz deficit: 5.7 percent of GDP in 2014; targeted to 3.1 percent of GDP in 2015 and eliminated by 2017. - End-user price hikes (prior actions): - Energy regulator to adopt and publish decision to raise retail gas prices to households by 284 percent on average, effective April 1, 2015 (two-tier increase: 231 percent first tier; 326 percent second tier; cost recovery rates 42 percent and 83 percent respectively). - Energy regulator to adopt and publish decision to raise retail heating prices to households by 67 percent on average, effective April 1, 2015. - Additional price adjustments in April 2016 and April 2017 to reach import parity by April 2017. - Specific pricing in MEFP: Tier 1 UAH 3600/tcm; Tier 2 UAH 7187/tcm (effective April 1, 2015); heating to UAH 625/gcal. - Naftogaz collection and restructuring: - Prior action: submit legislative amendments to improve Naftogaz collections; adoption by Parliament by March 31, 2015 (structural benchmark). - Independent audit of all Naftogaz receivables by June 30, 2015 (structural benchmark). - New gas market law to be presented and parliamentary approval by end-April 2015 (structural benchmark); implementation plan with World Bank staff effective by end-April 2015. - Increase funding to protect vulnerable households and expand energy efficiency investments (universal metering target by end-2016; heat metering 36 percent as of mid-2014). ### Structural reforms, governance, and SOE reform - Governance and anti-corruption: - Implement anti-corruption legislation; establish National Agency for Prevention of Corruption and National Anti-Corruption Bureau (NAB). - NAB establishment structural benchmark: by end-April 2015. - Strengthen AML framework by end-June 2015 (structural benchmark). - Asset disclosure reforms by end-March 2015. - Deregulation and business climate: - Reduction in permits, streamlining procedures, moratorium on inspections; business Ombudsman appointed December 2014. - Law on investor protection to be passed by end-March 2015. - SOE reform: - SOE sector: 1,833 active entities with over 1 million employees; transfers to SOE sector amounted to over 2½ percent of GDP in 2014 (excluding Naftogaz), dividends less than 0.2 percent of GDP. - By end-May 2015: develop restructuring strategy in consultation with IMF and WB, including inventory, ownership policy, corporate governance, prioritization, and transparent privatization (structural benchmark). - Fiscal risk assessment of SOEs by end-April 2015 (structural benchmark). ### Program modalities, conditionality, and monitoring - Arrangement: EFF with access equivalent to SDR 12.348 billion (900 percent of quota); phasing over 16 quarterly installments beginning with Board approval; frontloaded SDR 7.092 billion in 2015. - Schedule of purchases (selected): - Mar 11, 2015 — 3,546.000 Millions of SDRs; 4,999.86 Millions of US$; 258.45 Percent of quota (Condition: Board approval). - June 15, 2015 — 1,182.100 Millions of SDRs; 1,666.76 Millions of US$; 86.16 Percent of quota (Condition: First review and end-March 2015 performance criteria). - Total — 12,348 Millions of SDRs; 17,516 Millions of US$; 900 Percent of quota. - Conditionality: - Quarterly reviews with quantitative performance criteria (PCs) through end-June 2015 and indicative targets thereafter; PCs include ceilings on cash deficit of general government, combined general government and Naftogaz deficits, publicly guaranteed debt, floor on NBU’s NIR, ceiling on NBU NDA, and non-accumulation of external debt payment arrears. - Structural benchmarks phased and listed (e.g., amendments to NBU Law by end-April 2015; revenue administration reform plan by end-April 2015). - Monitoring and reporting: - Extensive reporting requirements across NBU, MoF, SFS, Naftogaz and other agencies with specified frequencies (daily, weekly, monthly, quarterly). - NBU to provide assurance reports within six weeks of each test date; external audit management letters to IMF within six weeks of completion. - Test date ceilings and detailed TMU definitions and adjustors specified (e.g., cumulative NIR floor: March (PC) -2,502 million US$; cash deficit of general government March (PC) 20,400 million UAH; combined deficit March (PC) 36,500 million UAH). ### Debt sustainability and stress tests (Annex II) - DSA conclusion: public debt sustainable with high probability under program and financing package including debt operation, conditional on: - (i) full implementation of policies; (ii) adequate and timely external financing from official sector; (iii) completion of debt operation; (iv) non-intensification of conflict in the East. - Public debt trajectory: - Debt projected to peak at 94 percent of GDP in 2015; decline to 71 percent of GDP by 2020 after debt operation. - External debt dynamics: - External debt close to 100 percent in 2014; peak at 158 percent of GDP in 2015; decline to 114.8 percent by 2020. - Stress test outcomes (selected): - Growth shock (cumulative decline over 2016–17): debt-to-GDP nearly 119 percent in 2017. - Real exchange rate shock similar to 2014: debt ratio remains above 100 percent throughout projections. - Combined macro-fiscal shock: debt rises above 200 percent of GDP in 2017. - Gross financing needs: - Average GFN during program and post-program period forecast to remain below 15 percent of GDP; debt operation would reduce average GFN during 2015–18 from 18 percent of GDP to 12 percent. - Gross external financing need (percent of GDP) example: 2015: 50.4 percent. ### Exceptional access assessment and Fund exposure - Exceptional access justified: exceptional balance of payments pressures; public debt trajectory projected to decline to around 70 percent of GDP by 2020 with debt operation; authorities performed reasonably under SBA given environment. - Fund exposure and capacity to repay: - Current GRA credit outstanding: SDR 3.785 billion (276 percent of quota). - If all purchases made, outstanding GRA credit would rise from about 276 percent of quota to peak at 963 percent of quota at end-2018. - Projected peak Fund exposure relative to GDP: 18.2 percent. - Charges projected: SDR 141.8 million remainder of 2015; average SDR 328 million a year over 2016–2019. - One-year Forward Commitment Capacity (FCC) impact: current FCC SDR 235,023.3 million; impact on approval -4,344.7 million SDR (-1.8 percent). - Fund decision: - Executive Board approved four-year EFF for Ukraine (SDR 12.348 billion; about US$17.5 billion); immediate disbursement SDR 3.546 billion (about US$5 billion), SDR 1.915 billion (about US$2.7 billion) for budget support. *Italic: IMF staff report text excerpt (Ukraine, February 27 and related annexes).* ### EXECUTIVE SUMMARY ### _cr1569 - EXECUTIVE SUMMARY ### Program purpose and scope - Ukraine needs a new economic reform program to restore stability and lay the basis for robust growth over the medium term. - The conflict in the East pushed Ukraine’s balance of payments and adjustment needs beyond what can be achieved under the current two-year SBA-supported program. - The authorities requested support under a four-year Extended Arrangement (SDR 12.348 billion; 900 percent of quota; about US$17.5 billion). - The extended arrangement provides broader and deeper reforms over a longer horizon and more financing time, building on the existing macroeconomic program. ### Core policy pillars - Securing financial stability: - (i) a strong monetary policy framework to restore price stability; - (ii) exchange rate flexibility to cushion the economy against external shocks; - (iii) a comprehensive strategy to strengthen banks’ financial health through bank recapitalization, reduction of related party lending, and resolution of impaired assets to regain public confidence and support economic recovery. - Strengthening public finances: - An expenditure-led adjustment will support fiscal consolidation in the coming years. - Together with energy sector reforms and the announced debt operation, this would reduce fiscal imbalances and achieve public debt sustainability with high probability. - Social protection schemes would be revamped to protect the poorest and alleviate social costs. - Advancing structural reforms: - Governance reforms, including anti-corruption and judicial measures. - Deregulation and tax administration reforms. - Reforms of state-owned enterprises to improve corporate governance and reduce fiscal risks. - Broader energy sector reforms, including Naftogaz’s restructuring, to increase energy efficiency and foster energy independence. ### Financing strategy and international support - The extended arrangement includes SDR 5.7 billion (US$8.1 billion) of additional net disbursements over 2015–18 due to longer repayment terms. - Significant financial support from the international community will supplement Fund financing. - The government announced consultations with public sector debt holders aimed at improving medium-term debt sustainability. - A total financing package of around US$40 billion will support the program over the four-year period. ### Risks and mitigation - Risks to the program are exceptionally high due to: - the weak state of the Ukrainian economy; - the presence of vested interests opposed to reforms; and - the ongoing conflict in the East. - Risks are mitigated by strong policies, including bold and frontloaded actions, and significant external financial support. - The authorities’ steadfast policy implementation and the resolution of the conflict in the East would materially strengthen prospects for stabilization and growth. ### Recent economic developments and indicators - Output and employment: - GDP contracted by 5.3 percent in 2014:Q3. - GDP contraction for 2014 is estimated at 6.9 percent (compared with 6.5 percent at the first SBA review). - Unemployment reached 8.9 percent as of end-September, up from 7 percent a year ago. - Inflation and exchange rate: - Inflation reached 24.9 percent at end-2014. - By end-December, the hryvnia had lost nearly half of its value relative to a year ago. - The NBU halted FX auctions on February 5, leading the hryvnia to fall immediately to around UAH 24–25/US$1. - Depreciation pressures continued and the hryvnia reached about UAH 29/US$1 on February 23. - Staff estimates that the exchange rate has significantly overshot and the current real exchange rate is significantly undervalued based on macroeconomic fundamentals. - Reserves and balance of payments: - Official reserves fell to US$6.4 billion at end-January 2015. - Balance of payments outflows and FX interventions depleted official reserves and opened a large financing gap. - International donor commitments over the next year were judged insufficient to restore SBA program reserve targets, prompting the shift to an Extended Arrangement. ### Macroeconomic outlook and adjustments - The escalation of the conflict in August 2014 and subsequent shocks increased BOP and adjustment needs beyond the SBA. - The EFF request reflects the need for: more financing, more time to implement reforms, and the time expected to restore full market access at longer maturities and sustainable rates. - The program will build on reforms initiated under the SBA while allowing broader and deeper reforms to be implemented over a longer period to correct structural imbalances. ### Mission and governance - Discussions were held in Kyiv during January 8–February 11, 2015. - The IMF mission team composition and senior IMF participants are listed in the executive summary approvals section. *IMF staff report: EXECUTIVE SUMMARY (Ukraine, February 27, 2015)* ### 8. The current account deficit declined substantially in 2014. Weak domestic demand, ### 8. The current account deficit declined substantially in 2014. Weak domestic demand, ### Current account and trade developments - Weak domestic demand, including from the ongoing fiscal consolidation, and the exchange rate depreciation reduced imports and the current account deficit substantially. - Exports declined by about 14½ percent in 2014. - Exports to Russia dropped by some 34 percent in 2014. - Some redirection of exports toward the EU has started mainly in sectors such as metals, mineral products and agriculture. - Russia accounts for about 18 percent of exports; the EU is now at 31½ percent. ### Banking sector stress and financial stability - By mid-February 2015, the banking system had lost about 27 percent of deposits since their peak in January 2014, equivalent to more than 12 percent of GDP. - NPLs rose from 12.9 percent of total loans at end-December 2013 to 19 percent at end-December 2014, and are expected to worsen further given recognition lags. - Return on assets was -4.1 percent at end-2014, reflecting losses including those from holding negative foreign exchange positions amid persistent hryvnia depreciation. - Banks’ liquidity positions worsened due to economic distress and deposit outflows. - Large NBU liquidity support reached about 9 percent of total system liabilities as of mid-February 2015. ### Political developments and near-term positive signals - In December, a five-party coalition government including both the president’s and the prime minister’s parties was formed, boosting the political influence of reformist forces. - Political leaders have repeatedly committed publicly to deep reforms; the new parliament approved the government’s program on reforms to address governance challenges and improve the business climate. - The trilateral agreement on a “winter package” for gas supply is being implemented as planned; Naftogaz cleared US$3.1 billion of arrears to Gazprom and gas import flows have resumed. The arbitration case in Stockholm is ongoing, with decisions now expected in the second half of 2016. - Efforts by the international community to find a sustainable solution to the conflict in the East are underway. ### Program objectives and strategies (four-year EFF-supported program) - Overarching aims: - Restore confidence and economic and financial stability through strong adjustment policies. - Lift medium-term growth through deep structural reforms. - Key stabilization measures to be pursued: - (i) An appropriately tight monetary policy to anchor expectations and a sustainable exchange rate policy that fosters steady reserve accumulation. - (ii) Bank recapitalization and resolution measures to strengthen banking system soundness, including measures to reduce related-party lending. - (iii) Fiscal adjustment consistent with a sustainable debt path. - (iv) Measures to keep Naftogaz’s deficit on course to be eliminated by 2017, and to restructure Naftogaz to increase efficiency and improve governance. - Key structural reforms to lift medium-term growth: - (i) Governance reforms, including anti-corruption and judicial reform measures. - (ii) Deregulation and tax administration reforms to improve business climate. - (iii) A comprehensive reform of state owned enterprises (SOEs) to enhance financial viability, reduce fiscal burden, and strengthen corporate governance. ### Program assumptions and buffers - The program’s success hinges on three main assumptions: - (i) Full and timely implementation of policies under the program. - (ii) Adequate and timely external financing from the official sector and, via a debt operation, the private sector. - (iii) Non-intensification of the conflict in the East. - Program buffers: - (i) Conservative near term projections. - (ii) Careful attention to the pace of adjustment, including social policies. - (iii) Increased economic flexibility, including a floating exchange rate. - If any key assumptions fail, macroeconomic outcomes would be at risk. ### Financing gap (2015–18) - Ukraine faces an exceptionally large financing gap of about US$40 billion over the program period (2015–18), equivalent to 31¼ percent of the estimated 2014 GDP. - About three-quarters of the gap results from the need to strengthen official reserves to around US$18.3 billion (66 percent of the IMF composite reserve metric) at end-2015 and US$35.2 billion (about 113 percent of the metric) at end-2018. - The 2015 financing gap is projected at US$21.4 billion, consisting of: - Reserve build-up: US$10.8 billion. - Underlying BOP gap: US$10.6 billion. - The US$10.6 billion underlying BOP gap in 2015 is split roughly 4:1 between the financial and current account of the BOP. - Drivers: continuing low confidence and moderate capital outflows, lack of external market access, low FDI, conservative rollover rates for banks and firms, reduced exports (especially services), and falling imports. ### Financing strategy and identified financing - Financing will be a combination of official and private funds with appropriate burden sharing; just under one-half of the financing gap is to be filled by Fund purchases. - Fund support: - The Fund will provide SDR 7.092 billion (about US$10 billion) towards the 2015 gap, and an additional SDR 5.256 billion (about US$7.5 billion) over the remainder of the program, subject to successful implementation. - About SDR 1.915 billion (about US$2.7 billion) of the first disbursement will be used for budget support. - International donors: - Commitments of US$7.2 billion so far, including US$1.5 billion under the SBA, US$5.1 billion of new budget support, and US$0.6 billion of other multilateral support for gas payments. - New commitments include Macro-Financial Assistance of over US$2 billion from EU, guarantees of US$2 billion from the U.S., and other bilateral support. - Swap agreement in process to activate CNY 15 billion (about US$2.4 billion) with the People’s Bank of China; discussions ongoing on use and possible extension beyond expiration in June 2015. - Debt operation: - Private sector involvement is required given high debt levels. - Authorities intend consultations with public debt holders; advisors hired. - Program-guided objectives for the debt operation: - (i) Generate about US$15 billion in financing during the program period. - (ii) Bring public and publicly guaranteed debt/GDP ratio below 71 percent of GDP by 2020. - (iii) Keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025. - The debt operation is expected to be concluded by the time of the first review. ### Macro framework projections - Overall: Economy expected to slowly return to growth with stabilization in late 2015 and more entrenched in 2016; structural reforms expected to attract investment and lift growth to potential in 2018. - Growth: - GDP contracting by about 5½ percent in 2015 (versus -3.4 percent in the January Consensus Forecasts). - Moderate recovery in 2016 with GDP projected to rise by 2 percent (versus +2.2 percent in the January Consensus Forecasts). - Deep recession in 2014–15 of more than 12 percent; real GDP expected to surpass pre-crisis level only by 2019. - Projections assume loss of economic capacity in parts of Eastern regions outside government control; contribution to 2015 GDP decline estimated at over 2 percentage points. - Inflation: - Projected to rise to about 27 percent in 2015 due to pass-through from large exchange rate depreciation, energy price hikes and base effects. - Projected to recede in 2016 as one-off effects subside and stabilize to around 5 percent over the medium term. - External account: - Current account deficit expected to narrow significantly to 1.4 percent of GDP, from 4.8 percent of GDP, as the REER depreciates cumulatively by 35 percent in 2014–15. - Decline also reflects lower energy imports and lower dividend payments; partially offset by adverse terms of trade and conflict-induced declines in transportation and tourism services. - REER expected to reverse some overshooting as capital inflows return and reserves rise; real exchange rate level projected to remain significantly below pre-crisis level to sustain competitiveness gains. - Financial account and reserves: - Sovereign market re-access delayed to late 2017 and expected to be moderate over the medium term. - Rollover rates for corporate and bank debt expected around 95–100 percent in 2016–17. - Under assumptions, reserves would strengthen to almost 100 percent of the Fund’s composite metric by end-2017. - Reserve target of US$26.7 billion (for end of the SBA, 2016:Q1) is now expected to be reached by 2017:Q3. - Debt projections: - Public and publicly guaranteed debt projected to peak at 94 percent of GDP in 2015, then decline to below 71 percent of GDP in 2020, supported by the debt operation. - With fiscal adjustment and restored growth, public debt ratio would continue to decline beyond 2020. - Private external debt expected to be reduced by moderate current account deficits and ongoing private debt restructuring. ### Risks to the outlook - Uncertainty remains exceptionally high; risks are predominantly on the downside. - Major downside risks: - Fighting in the East may resume and spread, undermining confidence, increasing direct loss of economic and export capacity, and raising military spending. - A disorderly debt operation could disrupt fragile private sector BOP equilibrium and voluntary private debt rollovers (some US$40 billion of short and medium-term private debt service payments are assumed to be rolled-over in 2015). - Creditor participation in the debt operation may fall short; creditors may balk and holdouts may try to free ride. - Slippages in program implementation (incomplete fiscal/financial reforms or delays in structural measures) would undermine stabilization and growth and leave debt at high levels. - Potential upside: - Early resolution of the geopolitical crisis would boost confidence. - Faster adaptation of production and exports to the new macroeconomic and external environment would support growth. *Source: IMF staff report text excerpt.* ### 18. Amidst a challenging environment, the NBU has taken several measures in recent ### 18. Amidst a challenging environment, the NBU has taken several measures in recent ### Monetary policy actions and objectives - In August, the NBU increased its overnight refinancing and deposit certificate rates by 250 basis points. - In November, the NBU increased its main policy rate by 150 basis points and its longer-maturity deposit rates by 50–100 basis points. - In early February, the NBU increased its main policy rate by 550 basis points to 19.5 percent. - The program will be anchored initially by very tight monetary policy targets to reduce demand for foreign currency; base and broad money growth will be negative in real terms. - Monetary policy will continue to be geared toward bringing inflation back to single digits by late 2016. - The NBU will set its main policy rate (the discount rate) positive in real terms on a 12–18 month forward-looking basis. - NBU monetary operations will reallocate surplus liquidity to banks in need through performing weekly two-sided tenders. ### Exchange rate, reserves, and administrative measures - The NBU tightened administrative restrictions and capital controls (footnote: includes increasing the export surrender requirement to 75 percent, reduced limit for individuals’ FX purchases, banned transfers abroad of proceeds from over the counter sales of securities and dividend repatriation for such securities, and tightened verification procedures for compliance with its regulations). - The authorities will maintain a flexible exchange rate regime while aiming for a gradual rebuilding of FX reserve buffers. - The NBU will not sell FX, except for central government needs and critical energy imports in amounts factored into the program. - From 2015:Q2, NBU sales to Naftogaz will be phased out. - Following approval of the program, frontloaded external disbursements in excess of US$10 billion in the first half of year will shore up international reserves. - In the first two months, with the Fund and other international partner’s disbursements, gross international reserves are programmed to nearly double. - Authorities will prepare by May 15, 2015 a plan for the gradual removal of the exchange restrictions and capital controls conditioned on sufficient improvement in financial and exchange rate stability and accumulation of international reserves as projected under the program. - The authorities introduced a temporary surcharge on imports (with exemptions for energy and pharmaceuticals) based on Article XII of the GATT (1994) agreements intended to contain BOP pressures; the authorities indicated their intention to remove this measure by end-2015. The WTO will consider the case in April. ### NBU institutional reform and inflation-targeting path - Legislative amendments to the NBU Law will be approved by end-April 2015 (structural benchmark); reform focuses on governance modifications, strengthening autonomy, and modalities to safeguard its balance sheet. - The legislation will also address concerns raised in the context of the 2014 Safeguards Assessment. - The NBU’s organizational structure and communications strategy will be revamped. - Efforts toward future adoption of inflation targeting will continue: the NBU will strengthen technical and operational capacity, refine its inflation projection capacity, and has discontinued past practice of using projections developed by the Cabinet of Ministers. - Once appropriate macro-financial conditions and institutional prerequisites are in place, the NBU will adopt inflation targeting. ### Banking system soundness — status and diagnostics - As of end-January 2015, the banking system’s capital adequacy ratio (CAR) stood at 13.8 percent, down from 15.9 percent at end-June. - NPLs have not yet peaked, and the recent large exchange rate depreciation is likely to reduce bank profits further. - Aggregate ratios mask vulnerabilities in individual banks; recent bank diagnostics confirmed reported bank losses. ### Bank recapitalization, restructuring, and resolution grouping and timelines - Group 1 banks: Nine large banks requiring capital increases; credible recapitalization plans and capital shortages reduced by 25 percent — recapitalization deadline end-June 2015. Banks failing to reduce shortage by 25 percent will face regulatory constraints; one of the nine large banks, accounting for about 2½ percent of the system assets, failed to submit a credible plan and was resolved. - Group 2 banks: The second largest 20 banks remain on track to complete recapitalization plans by end-February 2015. - Other banks: The NBU stepped up resolution of smaller banks; as of end-February 2015, 41 banks were resolved through the Deposit Guarantee Fund. ### Crisis management and supervisory enhancements - Parliament passed an anti-crisis law facilitating use of public funds for bank recapitalization and granting powers to the NBU to adopt extraordinary measures to ensure financial stability. - A Financial Stability Board has been established to identify systemic risks and recommend mitigating measures. - Preliminary information suggests several institutions intervened by the Deposit Guarantee Fund (DGF) had breached credit limits to insiders, highlighting opaque ownership structures and the need to strengthen supervisory framework on related lending. ### Revised recapitalization strategy and program safeguards - The NBU required revised recapitalization plans that credibly identify sources of funds and specific asset deleveraging plans. - Given shocks, an agreement allows banks that were solvent to meet a minimum capital adequacy ratio of 5 percent as of end-January 2016 and gradually reach 10 percent no later than end-December 2018. - The cost of bank restructuring in 2014–15 is estimated at 9¼ percent of GDP (upward revision from the SBA estimate). - The program contains a buffer of nearly 4 percent of GDP in public funds for bank recapitalization and restructuring. - Costs are estimated conservatively before asset recovery from failed banks. ### Asset recovery, forensic audits, and DGF management - Balance sheets of intervened banks were worse than books indicated; little value has so far been recovered from assets of failed banks. - Authorities and staff agreed more time is needed to dispose assets of failed banks than the 3 years foreseen in existing legislation. - Recovery process would be strengthened by introducing unlimited liability for related party loans (see related party reforms). - With World Bank assistance, the DGF will create a specialized unit to consolidate and dispose assets from resolved banks. - Two pilot forensic audits of failed banks are set to be launched to identify bad banking practices and inform regulation, supervision, and DGF functioning. ### Strengthening related party lending rules and supervisory process - Key legal amendments to be enacted: - Introduce unlimited liability on losses arising from loans granted directly or indirectly to shareholders holding 10 percent or more of total voting shares (prior action). - Amendments will grant legal powers to the NBU to presume existence of economic relationship between banks and borrowers on objective criteria unless banks prove otherwise. - Authorities will analyze and revise the current legal and regulatory framework on related parties with IMF and WB technical support. - Allow bank self-assessment to identify exposures above limits under the revised framework. - NBU will conduct supervisory review of bank reporting and preparation of unwinding plans with participation of accounting firms; banks will be given prudent time to reduce exposures based on credible unwinding plans. - NBU announced establishment of a specialized unit to follow up on credit exposures with economically related groups and individuals. ### Schedule for unwinding related party lending in 10 largest banks (2015) - February–March - Legislative amendments introducing unlimited liability of bank owners on losses arising from related party lending - Tightening of NBU regulations on lending limits to insiders - May - Banks report to NBU on related party exposure according to new legal and regulatory framework - July - NBU notifies banks on discrepancies - August - Banks respond on discrepancies - September - NBU completes prudential review and issues final report - October - Banks submit reduction plans to unwind related party exposure - November - NBU approves reduction plans ### NPLs, mortgage restructurings, and out-of-court frameworks - The NBU will issue a Code of Conduct by end-March 2015 to guide negotiations between borrowers in difficulty and banks, establish debt restructuring guidelines, and put in place an appeal process to induce fair and balanced negotiations. - By end-June 2015, authorities will establish a coordinated out-of-court restructuring system in line with international best practice. - By end-July, legislation will be submitted to strengthen the framework related to private debt restructuring covering foreclosure procedures, corporate and personal insolvency and tax incentives. ### Fiscal performance and 2015 budget stance - The cash budget deficit for 2014 is estimated at 4.6 percent of GDP, lower than the targeted 5.8 percent of GDP. - Fiscal saving nearly offset the higher than expected Naftogaz’s deficit of 5.7 percent of GDP, bringing the combined general government and Naftogaz deficit to 10.3 percent of GDP. - Adjusted for unpaid bills to the East (mainly pensions), the general government budget deficit would amount to about 5 percent of GDP. - In December 2014, the authorities adopted a 2015 budget targeting a deficit of UAH 65 billion (3½ percent of GDP). - The 2015 budget eliminates coal-mining subsidies equivalent to 0.6 percent of GDP in 2014 and reduces budgetary employment by 3 percent. - Pension savings in the budget include effectively freezing pensions during most of 2015, reducing the replacement rate from 70 percent to 60 percent for special pensions, and tightening eligibility for early retirement. - The budget continues to provide pensions to all pensioners who relocate from the ATO regions, but does not assume fiscal revenue from or spending to areas of active conflict in the East, except increased military spending. - The budget increases outlays on capital investment for immediate reconstruction needs; larger reconstruction spending contingent on additional concessional donor support. ### Tax policy changes adopted as part of the 2015 budget - Package grouped into three categories: - Simplification, reduction of labor tax burden and elimination of a distortive tax: abolishment/merging of small taxes and simplification of a single tax; reduction in average social security contribution rate conditional on significant increase in reported wage bill; abolition of foreign exchange sales tax for noncash transactions. The net negative revenue impact is estimated at 0.3 percent of GDP. - Permanent revenue-raising measures: expected to generate additional revenue of 2.3 percent of GDP on a permanent basis (measures include raising personal income taxation progressivity and taxing high pensions, maintaining the “military tax,” increasing the rate and base for capital income tax, increasing excise taxation including a new retail sales tax and raising tobacco excises, increasing property taxation, increasing royalties on natural resources, and other taxes). - Temporary measures: temporary import duty surcharge with estimated yield of 1 percent of GDP in 2015; extending VAT exemption on grain exports estimated at 0.5 percent of GDP. - Detailed revenue impacts (Percent of GDP): - Simplification of taxes and elimination of distortive taxes -0.5 - Eliminate foreign exchange sales tax for noncash transactions and increase for the cash transactions -0.3 - Eliminate small taxes and reform of the single tax -0.1 - Permanent revenue-raising measures 2.3 - Extend the personal income tax surcharge (military tax) until the completion of the military reform 0.4 - Introduce progressive personal income tax rates, eliminate preferential treatment for miners and expand the tax base to include passive incomes 0.1 - Tax pension benefits exceeding three minimum wages 0.1 - Increase the tax rate on passive incomes to 20 percent from 15 percent 0.1 - Remove nontaxable threshold on lottery wins 0.1 - Introduce a new excise tax on retail sales of alcohol, tobacco and fuels 0.4 - Equalize excise tax rate for unfiltered and filtered cigarettes 0.1 - Introduce a new luxury vehicle tax 0.1 - Expand the property tax base 0.0 - Increase royalties on natural resources 0.8 - Other measures 0.3 - Temporary measures 1.5 - Introduce temporary import duty surcharge 1.0 - Extend VAT exemptions on grain exports 0.5 _Excerpt from IMF staff report chapter: "18. Amidst a challenging environment, the NBU has taken several measures in recent" (IMF PDF content)._ ### 32. The program aims to strengthen fiscal sustainability through expenditure led ### _cr1569 - 32. The program aims to strengthen fiscal sustainability through expenditure led ### Fiscal framework and targets - Primary balance of the combined general government and Naftogaz will improve from a deficit of 6.9 percent of GDP in 2014 to a surplus of 1.6 percent of GDP in 2017. - Combined deficit path: - 2015 combined deficit: 7.4 percent of GDP (general government deficit of 4¼ percent of GDP and Naftogaz deficit of 3.1 percent of GDP). - Combined deficit reduced to 2.6 percent of GDP by 2018 (a general government deficit of 2.6 percent of GDP and a zero Naftogaz deficit already by 2017). - The 2015 combined deficit (7.4 percent of GDP) is higher than the envisaged combined deficit of 5.8 percent of GDP at the time of the first SBA review, reflecting: - adverse impact of the exchange rate depreciation on the Naftogaz deficit and the budget’s interest bill; - the need to provide additional funds for social assistance in view of the higher energy price hikes. - The budget was amended to target a deficit of UAH 78 billion (prior action) to reflect the updated macroeconomic framework and higher social spending net of partial offset from increased tax revenues from the domestic gas production subsidiary. ### Consolidation composition — revenue and expenditure measures (Percent of GDP) - Revenue measures: 3.3 - Simplification of taxes and elimination of distortive taxes (e.g. foreign exchange sales fee for noncash transactions): -0.5 - Increase in personal income tax base and rates: 0.7 - Introduction of a new excise tax on retail sales and increase in tobacco excise rate: 0.5 - Expansion of the property tax base and introduction of a new tax on luxury vehicles: 0.1 - Increase in the royalties on natural resources: 0.8 - Temporary measures (import duty surcharge, extension of VAT exemption on grain exports): 1.5 - Expenditure measures: -4.1 - Maintaining the nominal wage bill at 2014 level (except for military personnel): -0.8 - Delaying the minimum pension indexation until December 2015 and implementation of short-term pension measures including the reduction in replacement rates for special pensions and the reduction in pension benefits to the working pensioners: -2.3 - Reduction in subsidies to SOEs, including to the coal industry: -1.1 - Elimination of various uninsurable payments and limiting the size of various insurance payments: -0.1 - Increasing the energy subsidies to households while improving targeting of social assistance programs: 0.3 - Note: (-) sign implies savings. ### Budget composition and reallocation - Consolidation focuses on items that expanded fast in 2010–13 (wages, pensions, and subsidies) to make room for necessary increases in social assistance, interest, and capital expenditure. - The relatively modest headline general government adjustment (2 percentage points of GDP over the program period) masks a very strong effort to reduce the combined fiscal deficit. ### Social protection and household impact - Household macro effects and labor market: - Unemployment projected to increase to 11.5 percent in 2015 from 10.5 percent at end-2014. - Non-performing loans of households reached 20 percent at end-2014. - Pension spending had reached over 17 percent of GDP. - Short-term social protection measures: - Total spending on social assistance programs will reach 4.1 percent of GDP in 2015, an increase of 30 percent compared to 2014. - Social assistance with energy bills would more than double in 2015. - Unemployment benefit spending will rise by 15 percent. - IDP (Internally Displaced Person) spending would increase six-fold in 2015, reaching about 1/4 percent of GDP; current IDP assistance covers only about 40 percent of IDP families, prompting streamlining of administrative requirements. - Targeting and medium-term intent: - Existing social assistance programs (privileged housing utilities; means-tested subsidies for housing utilities; and a tariff compensation scheme introduced in 2014) will be consolidated to compensate poor households for higher energy bills. - Greater reliance on the general guaranteed minimum income (GMI) program to reduce fiscal cost of compensating measures, as GMI is better targeted to low-income households. - Estimated average household budget shares for utilities after social assistance would be 11-13 percent depending on the energy source used, but less than 10 percent of income for households in the bottom quintile. - Benefits are expected to cover over a quarter of all households. - Extensive public information campaigns planned to explain necessity of energy price increases and role of social assistance. ### Fiscal institutional reforms and revenue administration - Strengthen fiscal institutions to improve revenue collection and expenditure transparency and control (MEFP ¶24). - Revenue administration reform plan to overhaul the state fiscal service to be prepared in consultation with Fund staff by end-April 2015 (structural benchmark). The plan will include: - governance and institutional reforms to remove underperforming officials and reduce political interference; - subordinating the State Fiscal Service to the Ministry of Finance to improve coordination of tax policy and administration. - Specific reform elements: - Ensure all taxpayers meeting large taxpayer criteria will be transferred to the Large Taxpayer Office (LTO) by end-December 2015 (structural benchmark); simplify taxation of small business; establish an office for physical persons; and a transfer pricing department or office. - Restructure and rationalize tax offices, consolidating far-flung operations and local offices based on territory, size of potential taxpayers, and taxpayer services. - VAT compliance measures including electronic VAT administration; mandatory cash registers in retail establishments required starting July 1, 2015. - Public financial management reforms will focus on developing a credible medium-term budgetary framework, including expenditure ceilings, strengthening budget execution controls, and developing a cash management strategy. ### Energy policy: objectives and targets - Background: - Progress in 2014 to tackle Naftogaz’s deficit was eroded by exchange rate depreciation, reduced transit revenues and gas prepayments for 2015, leading to a higher than expected Naftogaz deficit of 5.7 percent of GDP (compared to 4.3 percent of GDP at the time of the first SBA review). - Program aims: - Bring gas and heating prices to cost recovery based on international gas prices by 2017 and eliminate Naftogaz’s deficit. - Strengthen the social assistance system for vulnerable households. - Support Naftogaz’s restructuring to reduce losses caused by governance issues and raise social acceptance of cost-recovery prices. - Strengthen Naftogaz’ collections of past and future bills, including smoothing bill payments to enhance compliance. - Encourage energy efficiency and raise investments in the sector. - Naftogaz targets: - Reduce Naftogaz’s deficit to 3.1 percent of GDP in 2015 and eliminate it by 2017. ### Energy price reforms and complementary measures - End-user price hikes (prior action): - Energy regulator to adopt and officially publish decision to raise retail gas prices to households by 284 percent on average, effective April 1, 2015. - Two-tier increase: 231 percent for the first tier (low consumption) and 326 percent for the second tier (higher consumption). - These represent a cost recovery rate of 42 percent (first tier) and 83 percent (second tier). - The first tier will act as a temporary lifeline tariff; the second tier will apply to all consumers during the off heating season. - Energy regulator to adopt and officially publish decision to raise retail heating prices to households by 67 percent on average, effective April 1, 2015. - Additional price adjustments in April 2016 and April 2017 will be needed to reach import parity for both gas and district heating by April 2017. - Industrial gas prices will continue to be adjusted to reflect exchange rate and gas import price movements. - Heating price increases will be accompanied by investment in energy efficiency measures (meters, regulators, insulation). - Improve collections (prior action): - Measures include option of smoothing bill payments, independent audit of Naftogaz receivables, and legislative amendments to improve Naftogaz collections. - Existing receivables exceeded over 2 percent of GDP in 2014. - Naftogaz restructuring: - New gas market law presented to the Cabinet of Ministers expected to be enacted by April 2015 (structural benchmark). - Law to provide framework for gas market functioning (unbundling, third party access to transmission system, corporate governance enhancements). - Implementation plan prepared with World Bank staff expected to become effective by end-April 2015. ### Structural reform priorities - Ambitious structural reforms are needed to remove growth bottlenecks: address endemic corruption, reduce regulatory burden, improve investor protection and contract enforcement, and support technological upgrading to raise productivity and attract investment. *Sources: Ukrainian authorities; and Fund staff estimates.* ### 44. The authorities have started to make important steps to address these challenges and ### The authorities have started to make important steps to address these challenges and improve the investment climate ### Reform steps and strategic focus - In 2014, parliament adopted a more transparent public procurement law and the cabinet imposed a moratorium on inspections of businesses by controlling agencies (except by fiscal authorities). - With EBRD assistance, a business Ombudsman was appointed in December 2014. - The government’s reform strategy approved in December focuses on: - Overhauling governance and anti-corruption: implement recently adopted anti-corruption legislation and establish the National Agency for Prevention of Corruption and the National Anti-Corruption Bureau (NAB, an investigative agency). - Improving business climate: concentrate on deregulation, decentralization and capacity building in the regions, and downsizing of public sector employment. - State-owned enterprise reform: introduce measures to strengthen corporate governance and management of state property. ### Deregulation and administrative reforms (selected measures and entry into force) - Reducing the number of permits (from 143 to 85 documents) and streamlining administrative procedures; April 26, 2014 - Streamlining procedures for termination of business activities of natural persons; July 7, 2014 - Limiting number of inspections; establishing a ban on scheduled state supervision inspections of a single business entity; August 17, 2014 - Streamlining procedures of obtaining permits; December 7, 2014 - Reducing the tax burden; reducing number of taxes and levies, shortening the time needed to complete the compulsory procedures to declare and pay taxes, simplifying procedures for taxpayers which temporarily suspend their business activities to submit their tax reports. January 1, 2015 - Improving the system of State regulation of transfer pricing; bringing provisions on tax control over transfer pricing in line with the OECD Guidelines; January 1, 2015 - Granting public access to information on real estate from the State Register of Proprietary Rights; February 6, 2015 ### Progress on SOE efficiency and governance - Developed a concept document on comprehensive reform of SOEs. - Prepared new transparency and accountability guidelines for SOEs. - Prepared recommendations for improving financial plans approval procedure. - Developed an action plan to audit top 50 SOEs. - Changed nomination procedure for CEOs of the key SOEs and selected members of an independent Selection Committee. - Reviewed the privatization process and prepared recommendations for its improvement. ### Anti-corruption and AML measures - Key elements of a robust anti-corruption legal framework are now in place. - Legislative amendments adopted to ensure the National Anti-corruption Bureau (NAB) is subject to a robust external oversight process, can access all relevant information for investigations (including of high level officials), and is staffed with high integrity officials (prior action). - Amendments to the Anti-Money Laundering (AML) law, the criminal code, and asset disclosure requirements have strengthened tools to fight corruption and related money laundering. - Authorities committed to establish the anti-corruption investigative agency (structural benchmark) and start its investigations. - Strengthening implementation of the AML framework is a structural benchmark to prevent misuse of the financial sector to launder proceeds of corruption. ### Judicial reform and enforcement - Reform program includes measures on judicial reform, strengthening court efficiency, and procedures for effective enforcement, following recommendations of the July Diagnostic Report. - The law on the Judiciary and the Status of Judges will be sent to the Venice Commission to strengthen judicial independence in line with European standards. - To improve efficiency in civil litigation, a law will be enacted on a selective increase of court fees (structural benchmark). - Authorities will seek to strengthen procedures on Order for Payment and Bank Account Seizures (Garnishment) which could potentially cover up to 80 percent of all commercial claims in the country (structural benchmark). - Additional measures: passage of a law establishing a profession of private enforcement agents; develop a reorganization plan for enforcement agencies. - By end-March 2015, a reorganization plan will be submitted for the public prosecution. ### SOE sector scale, fiscal impact, and planned reforms - The SOE sector comprises 1,833 active entities (out of 3,350 registered public enterprises) with over 1 million employees—about quarter of total public employment. - In 2014, transfers from government to the SOE sector amounted to over 2½ percent of GDP (excluding the large transfers to Naftogaz), while dividends were less than 0.2 percent of GDP. - State asset ownership and management arrangements are highly decentralized, fragmented, and characterized by numerous conflicting roles and responsibilities. - By end-May 2015, authorities plan to develop a restructuring strategy (in consultation with IMF and World Bank staff) with a specific timeline to: - (i) improve budgetary oversight, - (ii) implement a comprehensive ownership policy, - (iii) strengthen corporate governance, - (iv) prioritize enterprises subject to restructuring, - (v) transparent privatization of identified assets in the medium run (structural benchmark). - Efforts include adopting international corporate governance standards for individual enterprises and undertaking a fiscal risk assessment of the SOEs. ### Program modalities: access, phasing, and conditionality - Staff supports a new extended arrangement under the EFF with an access level equivalent to SDR 12.348 billion or US$17.5 billion, representing an additional amount of SDR 4.345 billion (about US$5.8 billion) relative to amounts committed but not purchased under the SBA. - Phasing: disbursements over 16 quarterly installments beginning with Board approval and some frontloading gross disbursements of SDR 7.092 billion (about US$10 billion) in 2015 to achieve a minimum level of reserves. Of this, SDR 1.915 billion (about US$2.7 billion) will be used for budget support. - Conditionality: - Quarterly reviews proposed on a quarterly basis; first review based on targets for end-March 2015. - Quantitative performance criteria (PCs) set through end-June 2015 and indicative targets through the remainder of the year; quantitative PCs include a ceiling on the cash deficit of the general government and on the combined deficits of the general government and Naftogaz; a ceiling on publicly guaranteed debt; a floor on NBU’s NIR; a ceiling on the NBU’s NDA; and non-accumulation of external debt payment arrears by the general government. - Structural benchmarks are phased in line with authorities’ capacity and address outstanding benchmarks under the SBA. ### Exceptional access assessment against IMF criteria - Criterion 1: Ukraine is experiencing exceptional balance of payments pressures on both current and capital accounts; official reserves have fallen to dangerously low levels; risks of further disruptions from geopolitical tensions. - Criterion 2: Public debt to GDP ratio is projected to decline steadily to around 70 percent of GDP by 2020; debt service burden indicators would remain significantly below DSA higher risk benchmark. This outcome relies on fiscal adjustment, additional official financing on adequate terms, and a debt operation to restore medium-term debt sustainability with high probability. - Criterion 3: Program and financing mix aim to stabilize the economy and revive growth; staff anticipates good prospects for regaining greater access to private capital markets before the end of the program period with successful implementation and broad international support. - Criterion 4: Authorities have performed reasonably well under the SBA despite adverse environment (strong budget implementation, increases in household gas and heating prices, administrative reform in the NBU, decisive resolution of weak banks, steps to strengthen anti-corruption and AML); authorities are committed to strong prior actions for this program and capacity is judged sufficient to deliver core elements of reform. ### Capacity to repay the Fund and program risks - Under the baseline, Ukraine’s capacity to repay the Fund remains adequate but subject to exceptional risks. - With an extended EFF, the repayment period is extended through 2028 so total repurchases during 2017–19 are reduced from US$12.2 billion (SBA) to US$4.9 billion (EFF). - Repayment to the Fund over the next five years would peak at 7.6 percent of reserves in 2018. - By the end of the arrangement in early 2019, outstanding credit to the Fund is expected to peak at about 17.0 percent of GDP, or 54 percent of gross reserves. - Debt service to the Fund as a ratio of exports of goods and services would peak at 3.5 percent in 2018. - Main risks: - Geopolitical developments and potential prolonged or intensified conflict. - Weak program implementation. - Failure to allow sufficient exchange rate and fiscal/energy price adjustment could lead to continuing balance of payments problems and raise repayment risks. - A four-year arrangement supports deeper reforms but commits Fund resources for a longer period. *Source: Ukrainian authorities and IMF staff text as provided in the content unit.* ### 60. A safeguards assessment mission was completed in August 2014 and identified some ### _cr1569 - 60. A safeguards assessment mission was completed in August 2014 and identified some ### Safeguards assessment findings (paragraph 60) - A safeguards assessment mission was completed in August 2014 and identified some deficiencies at the NBU. - Deficiencies included: - Strain on NBU’s balance sheet owing to liquidity lending to commercial banks and purchases of domestic government securities. - Mandated profit distributions from the NBU to the government that were far in excess of permitted distributable amounts under the NBU Law. - Limited NBU Council mandate to establish sound oversight arrangements of the daily management of the NBU. - Authorities are taking actions to strengthen internal controls of the NBU (MEFP ¶37). - The government and NBU signed an agreement in May 2014 on respective responsibilities for servicing obligations stemming from direct budget support under the SBA. - Existing legislative framework limits distribution of dividends to a maximum of 25 percent of the projected annual amount before the financial audit is completed. ### Staff appraisal — program context and objectives (paragraphs 61–64) - Despite tangible progress under the SBA, the crisis increased Ukraine’s BOP and adjustment needs beyond what can be achieved under the current program. - The SBA-supported program pursued ambitious policies to: - Stabilize the financial system. - Strengthen fiscal sustainability. - Modernize and restructure the energy sector. - Improve governance. - Ongoing shocks and outcomes: - Conflict in the East and loss of confidence continue to affect the economy and banking system. - Deep recession and sharp exchange depreciation aggravated vulnerabilities, weakened bank balance sheets, and raised public debt. - New four-year Fund-supported program aims to decisively address these challenges by restoring financial and economic stability and resolving long-standing structural obstacles to growth, including weak corporate governance. - Authorities recognize that resolute and full implementation is critical to: - Restore confidence and growth. - Bring inflation back to single digits. - Keep external deficits manageable. - Replenish international reserves to adequate levels. - Policy framework: - Implementation of a flexible exchange rate regime is expected to help cushion the economy against external shocks, while sizable external financial support would enable gradual rebuilding of reserve buffers. - Appropriate reserve targets are included in the program to support the new regime. - Upgrading NBU’s monetary policy toolkit and operational framework is vital. Recent steps to regain control over monetary aggregates and a tight monetary stance are necessary to bring inflation back into single digits. - Authorities commit to maintain policy rates positive in real terms and to eliminate capital controls and restrictions at an appropriately calibrated pace as the balance of payments improves. ### Banking sector recovery and fiscal strategy (paragraphs 65–66) - Banking sector: - Strong and swift actions are needed to rehabilitate the banking system; success requires a comprehensive strategy and decisive actions to overcome vested interests and establish a modern, sound, and adequately supervised banking system. - Staff welcomes progress in recapitalizing systemic banks and resolving weak non-systemic banks. - Decisive implementation of the banking strategy is crucial to regain public confidence and support economic recovery. - Fiscal policy: - The program’s fiscal adjustment path seeks to reduce fiscal imbalances and restore public debt sustainability with high probability while alleviating social costs to the most vulnerable. - Restraining current spending requires expenditure rationalization, including control over wages, pension reforms, and reforms of the large public sector. - The 2015 budget and the approved supplementary budget are cited as a good start; authorities should resist pressures to increase spending or adopt low-quality ad-hoc policies. - Strengthening social safety net programs alongside fiscal consolidation and energy policies is crucial to alleviate social costs and build support for reforms. ### Energy sector and structural reforms (paragraphs 67–68) - Naftogaz and gas sector: - Reform of the gas sector is necessary to increase energy efficiency, attract investment, promote domestic production, and alleviate governance problems. - Authorities committed to eliminate Naftogaz’s deficit by 2017 by increasing tariffs, improving collection rates, lowering costs, and fundamentally restructuring the company. - The authorities plan to increase funding to protect the most vulnerable from the impact of tariff increases. - Timely and resolute implementation is emphasized given past weak implementation records. - Structural reform priorities: - Addressing weak governance and improving the business climate is critical to achieve higher growth and restore trust in government. - Perceived corruption, including in the judiciary, reduces investment attractiveness and prevents Ukraine from unlocking full growth potential. - By addressing core structural challenges, confidence is expected to gradually return and place the economy on a more dynamic path with better shock-absorbing capacity. ### Risks, external support, and program approval (paragraphs 69–71) - Risks: - Program risks are described as exceptionally high. - Key risks stem from the conflict in the East and the potential for escalation that could undermine stabilization efforts and structural reforms. - Ukraine’s track record on program implementation is weak and punctuated by repeated false starts, with past stalling in key policy areas (exchange rate regime, energy sector, anti-corruption, agricultural VAT) due to vested interests. - Recent performance under the SBA is cited as evidence of stronger resolve. - External support and debt operation: - Staff welcomes support pledged by international partners and notes that the authorities’ intended debt operation will be critical to program success. - Bilateral financial support is needed to give authorities space to implement the program and to support reconstruction if downside risks materialize. - The authorities’ intention to undertake a debt operation is seen as critical to restoring a high probability of debt sustainability and to providing necessary financing. - IMF financing and policy exceptions: - Staff supports approval of Ukraine’s four-year Extended Arrangement under the EFF with access equivalent to SDR 12.348 billion (900 percent of quota). - Staff supports the authorities’ request for approval, for a period of 12 months, of the retention of the exchange restrictions and multiple currency practices inconsistent with Article VIII Sections 2 (a) and 3 on the grounds that they are non-discriminatory, imposed for balance of payments reasons, and temporary. *Italic: Extracted content from the IMF country report text unit provided.* ### 0. Ukraine: Proposed Schedule of ### 0. Ukraine: Proposed Schedule of Purchases Under the Extended Arrangement ### Schedule of Purchases and Key Figures - Mar 11, 2015 — 3,546.000 Millions of SDRs; 4,999.86 Millions of US$; 258.45 Percent of quota. Condition: Board approval of extended arrangement. - June 15, 2015 — 1,182.100 Millions of SDRs; 1,666.76 Millions of US$; 86.16 Percent of quota. Condition: First review and end-March 2015 performance criteria. - September 15, 2015 — 1,182.100 Millions of SDRs; 1,666.76 Millions of US$; 86.16 Percent of quota. Condition: Second review and end-June 2015 performance criteria. - December 15, 2015 — 1,182.100 Millions of SDRs; 1,666.76 Millions of US$; 86.16 Percent of quota. Condition: Third review and end-September 2015 performance criteria. - March 15, 2016 — 437.975 Millions of SDRs; 621.92 Millions of US$; 31.92 Percent of quota. Condition: Fourth review and end-December 2015 performance criteria. - June 15, 2016 — 437.975 Millions of SDRs; 621.92 Millions of US$; 31.92 Percent of quota. Condition: Fifth review and end-March 2016 performance criteria. - September 15, 2016 — 437.975 Millions of SDRs; 621.92 Millions of US$; 31.92 Percent of quota. Condition: Sixth review and end-June 2016 performance criteria. - December 15, 2016 — 437.975 Millions of SDRs; 621.92 Millions of US$; 31.92 Percent of quota. Condition: Seventh review and end-September 2016 performance criteria. - March 15, 2017 — 437.975 Millions of SDRs; 626.30 Millions of US$; 31.92 Percent of quota. Condition: Eigth review and end-December 2016 performance criteria. - June 15, 2017 — 437.975 Millions of SDRs; 626.30 Millions of US$; 31.92 Percent of quota. Condition: Ninth review and end-March 2017 performance criteria. - September 15, 2017 — 437.975 Millions of SDRs; 626.30 Millions of US$; 31.92 Percent of quota. Condition: Tenth review and end-June 2017 performance criteria. - December 15, 2017 — 437.975 Millions of SDRs; 626.30 Millions of US$; 31.92 Percent of quota. Condition: Eleventh review and end-September 2017 performance criteria. - March 15, 2018 — 437.975 Millions of SDRs; 630.68 Millions of US$; 31.92 Percent of quota. Condition: Twelfth review and end-December 2017 performance criteria. - June 15, 2018 — 437.975 Millions of SDRs; 630.68 Millions of US$; 31.92 Percent of quota. Condition: Thirteenth review and end-March 2018 performance criteria. - September 15, 2018 — 437.975 Millions of SDRs; 630.68 Millions of US$; 31.92 Percent of quota. Condition: Fourteenth review and end-June 2018 performance criteria. - December 15, 2018 — 437.975 Millions of SDRs; 630.68 Millions of US$; 31.92 Percent of quota. Condition: Fifteenth review and end-September 2018 performance criteria. - Total — 12,348 Millions of SDRs; 17,516 Millions of US$; 900 Percent of quota. - Note: For 2015-18, the USD/SDR rates used in this table are: 1.41, 1.42, 1.43, 1.44, respectively. *Amount of purchase* ### Annex I — Regional Economic Developments in Ukraine: Tale of Three Regions - General finding: Economic developments in the conflict region of Donbass are increasingly decoupling from the rest of the country. - 2014 impacts in Donetsk and Luhansk: - Industrial production and exports plummeted; agriculture was an exception. - Retail sales dropped significantly due to declining real wages, growing outward migration, and accumulation of economy-wide wage arrears. - Rest of country: - Some signs of stabilization though activity and trade remain depressed. - Decline in industrial production and exports in the South and Western regions appears to have bottomed out, partly reflecting economic orientation towards the EU. - Domestic demand continues to weaken but at a slower pace than the conflict zone; retail sales and imports persistently decline. - Banking sector and deposits: - Deposit withdrawals were more sizable in the east, reflecting low confidence. - In 2014 household deposit outflows in Donetsk and Luhansk reached 57 percent and 50.9 percent, respectively; Ukraine average household outflow was 24.3 percent. - Regional deposit and credit growth table excerpts (percentage, at fixed ER of 7.993 UAH/US$) — NPLs at end-Dec 2014 (overdue loans to total loans in percent) and deposit/credit changes: - Donetsk: Household deposit -57.0; Total household -48.2; Corporate 15.4; Total 15.0 (table formatting preserved as in source). - Luhansk: Household deposit -50.9; Total household -2.9; Corporate 31.3; Total 42.4. - Rest of Ukraine: Household deposit -20.1; Total household -11.1; Corporate 12.7; Total 11.0. - Ukraine, total: Household deposit -24.3; Total household -13.2; Corporate 13.0; Total 11.4. - Fiscal and tax revenue developments: - Tax revenues from the East declined heavily; evacuation of government offices effective from December 1, 2014 for areas not directly controlled by authorities exacerbated declines. - Tax collection in the rest of the country grew in nominal terms due to high inflation and exchange rate depreciation. - Internal displacement and social assistance: - Public wage and pension payments in rebel-controlled areas halted. - Over 500,000 pensioners obtained internally displaced person (IDP) status to claim pensions. - Government offers social assistance to support the reallocation process. - Growth rates of budget revenue (2014 relative to 2013), share of total in 2014: - East Ukraine (Donetsk and Luhansk): State Budget -32; Local Budgets -23; Social Security Funds -21; Total -26; Share of total in 2014: 6 13 14 9 (table formatting preserved as in source). - Rest of Ukraine: 137 45 (format preserved). - Ukraine, Total: 82 -15 (format preserved). ### Annex II — Debt Sustainability Analysis (DSA): Main Findings and Assumptions - Overall DSA conclusion: - Under the policy and financing package supporting the proposed extended arrangement under the EFF including the expected outturn from the debt operation, Ukraine’s public debt is assessed as sustainable with high probability, conditional on four main assumptions: - (i) full implementation of policies under the program; - (ii) adequate and timely external financing from the official sector; - (iii) completion of a debt operation with holders of Ukraine’s public sector debt; and - (iv) the non-intensification of the conflict in the East. - Public debt trajectory: - Public debt projected to peak at 94 percent of GDP in 2015. - Debt projected to decline to 71 percent of GDP by 2020 after the envisaged debt operation. - External debt: - External debt projected to peak at about 158 percent of GDP in 2015. - Presence of significant corporate assets in foreign currencies provides a buffer. - Gross financing needs (GFN): - Average gross financing needs during the program and post-program period forecast to remain below 15 percent of GDP. - Debt operation would reduce gross financing needs during 2015-18 from an average of 18 percent of GDP to 12 percent. - Key macroeconomic and fiscal assumptions (Section A): - Real GDP growth: projected at -5½ percent in 2015, rising to 4 percent by 2018. - Inflation (GDP deflator): projected to peak at 27½ percent in 2015. - Combined general government and Naftogaz overall deficit: projected to shrink from 10.1 percent of GDP in 2014 to 7.4 percent of GDP in 2015, then consolidate to 2.7 percent of GDP by 2020. - Primary surplus: near-term primary surplus of 1.1 percent of GDP in 2015; medium-term target primary surplus of about 1.6 percent of GDP. - Banking system support: - Program estimate of fiscal needs to support bank restructuring in 2014-15: 9¼ percent of GDP. - A buffer of nearly 4 percent of GDP in public funds is incorporated to absorb additional bank recapitalization and resolution needs. - Debt operation objectives: - (i) generate US$15 billion in public sector financing during the program period; - (ii) bring public and publicly guaranteed debt/GDP from a projected 80 percent of GDP to under 71 percent of GDP by 2020; - (iii) keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025. - Official financing terms: - Multilateral and bilateral funding provided at low borrowing costs (tied to Euribor/Libor and fixed annual rates below two percent, respectively), with loans amortizing in the range of 10-20 years (multilaterals around 5 year grace period). - IMF lending calibrated on EFF terms. - Market access assumption: - Assumed re-access to international capital markets by late 2017, with time to re-access about 3 years based on past experience. - Public and publicly guaranteed debt composition (2014, table data preserved): - Public and publicly guaranteed debt: UAH 1116 Billion; USD 70.8 Billion; Percent of GDP 72.7; Percent of total 100.0. - Domestic debt: UAH 495 Billion; USD 31.4 Billion; Percent of GDP 32.3; Percent of total 44.4. - Direct debt in UAH: UAH 400 Billion; USD 25.4 Billion; Percent of GDP 26.1; Percent of total 35.8. - Direct debt in FX: UAH 67 Billion; USD 4.3 Billion; Percent of GDP 4.4; Percent of total 6.0. - Guaranteed debt: UAH 28 Billion; USD 1.8 Billion; Percent of GDP 2.5. - External debt: UAH 621 Billion; USD 39.4 Billion; Percent of GDP 40.5; Percent of total 55.6. - External direct debt: UAH 495 Billion; USD 31.4 Billion; Percent of GDP 32.3; Percent of total 44.4. - Multilateral: UAH 171 Billion; USD 10.8 Billion; Percent of GDP 11.1; Percent of total 15.3. (of which: IMF budget support UAH 86 Billion; USD 5.4 Billion; Percent of GDP 5.6; Percent of total 7.7) - Bilateral: UAH 43 Billion; USD 2.7 Billion; Percent of GDP 2.8; Percent of total 3.9. (Includes EU) - Sovereign Eurobonds: UAH 273 Billion; USD 17.3 Billion; Percent of GDP 17.8; Percent of total 24.4. - Local government Eurobonds: UAH 90.6 Billion; USD 0.6 Billion; Percent of GDP 0.6; Percent of total 0.8. (Issued by the city of Kyiv) - External guaranteed debt: UAH 126 Billion; USD 8.0 Billion; Percent of GDP 8.2; Percent of total 11.3. (of which: IMF loans to NBU UAH 34 Billion; USD 2.2 Billion; Percent of GDP 2.3; Percent of total 3.1; of which: Eurobonds UAH 29 Billion; USD 1.8 Billion; Percent of GDP 1.9; Percent of total 2.6) - Public Sector DSA results and risks (Section B): - Debt reached 73 percent of GDP at end-2014, up about 30 percentage points from 2013. - Without the debt operation, public debt would peak at about 94 percent of GDP; after the debt operation and fiscal adjustment it is expected to converge to 71 percent of GDP by 2020. - Heat maps and fan charts indicate significant risks to debt sustainability; asymmetric fan charts show risks skewed upward if fiscal consolidation and FX stabilization fall short. - Stress test outcomes: - Growth shock (cumulative growth decline of over 9 percentage points in 2016–17): debt-to-GDP ratio reaches nearly 119 percent in 2017. - Real exchange rate shock similar to 2014: debt ratio remains above 100 percent throughout the projection period. - Combined macro-fiscal shock (aggregating shocks to real growth, interest rate, primary balance and exchange rate): debt rises above 200 percent of GDP in 2017. - Contingent liabilities shock (large banking sector deterioration with associated fiscal costs and a growth shock of 14 percentage points below baseline in 2016–17): debt peaks at 116 percent of GDP in 2017. - Gross financing needs under baseline breach the high-risk benchmark of 15 percent of GDP only in 2015 due to extensive support to banking sector and Naftogaz; average GFN for remainder of program period below 10 percent of GDP. - Under the combined shock, average GFN rises to more than 20 percent of GDP during the projection period. - External Sector DSA: - External debt dynamics point to significant solvency concerns at peak but corporate foreign currency assets and a sustained reduction in current account deficits plus voluntary private debt restructuring would put external debt on a downward path. - Growth and export shocks would keep external debt more elevated than under the baseline. _International Monetary Fund staff estimates._ ### 12. Baseline projections suggest that external debt could drop by 44 percentage points of ### 12. Baseline projections suggest that external debt could drop by 44 percentage points of GDP by 2020, while remaining high. ### Baseline projection and drivers - Baseline assumptions: successful implementation of policies under the program; adequate and timely external financing from the official and private sectors; non-intensification of the conflict in the East. - Gross external debt-to-GDP ratio: - Close to 100 percent in 2014. - Peak at 158 percent of GDP in 2015. - Decline to 115 percent of GDP by end-2020. - Net decline across 2016–2020 implies a drop of 44 percentage points of GDP by 2020 (from the 2015 peak to 115 percent). - External adjustment contribution: - Trade balance of goods and services moves from a deficit of close to 10 percent of GDP in 2013 to almost balance in the medium term. - Debt operation reduces current account income balance pressures, supporting the downward path. - Private sector buffers: - Private corporations hold foreign currency assets covering 86 percent of their foreign currency liabilities as of September 2014, reducing net exposure to external shocks and supporting external debt service. - Several large corporations have engaged in voluntary debt restructuring/rollover operations. ### Downside risks and shock scenarios - Main risk drivers: macroeconomic shocks; quick reversal of recent external adjustment; protracted war-induced supply shocks; delays in finding markets outside CIS. - Current account deterioration scenario: - If the current account deteriorates on average by 1 percent of GDP per year compared to the baseline, the external debt ratio would increase by about 10 percent of GDP by 2020. - Growth shock scenario: - A half historical standard deviation shock from the baseline growth path (about 2½ percentage points lower growth on average per year) increases the external debt ratio by about 25 percentage points of GDP by 2020. - FDI and confidence effects: - Reduced FDI due to prolongation or intensification of the conflict in the East would significantly affect external debt dynamics, producing a sizable upward shift in the debt adjustment path. - Stress test outcomes (Figure 6 highlights): - Historical scenario average: 77 (external debt in percent of GDP, historical average). - Baseline average projection box: 115. - Individual shocks produce higher paths: Interest rate shock box: 119; Growth shock box: 138; Noninterest current account shock box: 123; Combined shock box: 136; Real depreciation (30% depreciation) scenario box: 150. ### Program external debt sustainability framework (Annex II. Table 1 key figures) - Baseline: external debt (percent of GDP) - 2012: 76.6 - 2013: 78.3 - 2014: 102.4 - 2015: 158.4 - 2016: 149.5 - 2017: 141.2 - 2018: 134.3 - 2019: 125.0 - 2020: 114.8 - Change in external debt (percent of GDP) - 2012: -0.7 - 2013: 1.6 - 2014: 24.2 - 2015: 55.9 - 2016: -8.9 - 2017: -8.3 - 2018: -6.9 - 2019: -9.3 - 2020: -10.2 - Identified external debt-creating flows (4+8+9) (percent of GDP) - 2012: -4.3 - 2013: 0.8 - 2014: 37.5 - 2015: 6.5 - 2016: -3.3 - 2017: -6.6 - 2018: -8.4 - 2019: -7.1 - 2020: -5.0 - Components (selected, percent of GDP) - Current account deficit, excluding interest payments: - 2012: 2.4 - 2013: 3.2 - 2014: -1.3 - 2015: -7.3 - 2016: -6.7 - 2017: -6.4 - 2018: -6.0 - 2019: -5.0 - 2020: -4.1 - Deficit in balance of goods and services: - 2012: 8.2 - 2013: 8.7 - 2014: 4.2 - 2015: 0.4 - 2016: 0.6 - 2017: 0.5 - 2018: 0.5 - 2019: 0.7 - 2020: 1.2 - Exports (percent of GDP): - 2012: 51.2 - 2013: 47.6 - 2014: 53.7 - 2015: 72.5 - 2016: 71.8 - 2017: 69.7 - 2018: 67.7 - 2019: 66.0 - 2020: 64.3 - Imports (percent of GDP): - 2012: 59.4 - 2013: 56.3 - 2014: 57.9 - 2015: 72.9 - 2016: 72.3 - 2017: 70.2 - 2018: 68.2 - 2019: 66.7 - 2020: 65.4 - External debt-to-exports ratio (percent) - 2012: 149.5 - 2013: 164.5 - 2014: 190.7 - 2015: 218.5 - 2016: 208.3 - 2017: 202.6 - 2018: 198.3 - 2019: 189.5 - 2020: 178.6 - Gross external financing need (billions of U.S. dollars) - 2012: 85.4 - 2013: 73.7 - 2014: 66.0 - 2015: 43.0 - 2016: 48.2 - 2017: 43.8 - 2018: 45.2 - 2019: 47.1 - 2020: 51.0 - Gross external financing need (percent of GDP) - 2012: 48.6 - 2013: 41.0 - 2014: 51.5 - 2015: 50.4 - 2016: 52.0 - 2017: 43.0 - 2018: 40.4 - 2019: 38.4 - 2020: 37.9 ### Key macroeconomic baseline assumptions (selected) - Real GDP growth (percent): - 2012: 0.2 - 2013: 0.2 - 2014: -6.9 - 2015: -5.5 - 2016: 2.0 - 2017: 3.5 - 2018: 4.0 - 2019: 4.0 - 2020: 4.0 - GDP deflator in U.S. dollars (change in percent): - 2012: 7.3 - 2013: 2.0 - 2014: -23.4 - 2015: -29.3 - 2016: 6.3 - 2017: 6.2 - 2018: 5.6 - 2019: 5.5 - 2020: 5.5 - Nominal external interest rate (percent): - 2012: 8.0 - 2013: 8.0 - 2014: 4.9 - 2015: 5.7 - 2016: 5.4 - 2017: 5.5 - 2018: 5.6 - 2019: 5.4 - 2020: 5.6 - Growth of exports of goods and services (U.S. dollar terms, percent): - 2012: 1.3 - 2013: -5.1 - 2014: -19.5 - 2015: -10.0 - 2016: 7.4 - 2017: 6.8 - 2018: 6.7 - 2019: 6.9 - 2020: 6.9 - Growth of imports of goods and services (U.S. dollar terms, percent): - 2012: 5.4 - 2013: -3.1 - 2014: -26.6 - 2015: -16.0 - 2016: 7.6 - 2017: 6.8 - 2018: 6.7 - 2019: 7.3 - 2020: 7.6 - Current account balance, excluding interest payments (percent of GDP): - 2012: -2.4 - 2013: -3.2 - 2014: 1.3 - 2015: 7.3 - 2016: 6.7 - 2017: 6.4 - 2018: 6.0 - 2019: 5.0 - 2020: 4.1 - Net non-debt creating capital inflows (percent of GDP): - 2012: 7.0 - 2013: 6.7 - 2014: -1.9 - 2015: 3.4 - 2016: 1.6 - 2017: 2.9 - 2018: 4.5 - 2019: 3.9 - 2020: 2.8 ### Program conditions and implications - Implementation and financing needs: - Baseline outcome requires adequate and timely external financing from official and private sectors. - Non-intensification of the conflict in the East is a stated conditional assumption for the baseline. - Private-sector actions: - Existing voluntary corporate restructuring/rollovers and large foreign currency asset coverage (86 percent) are important buffers. - Vulnerabilities: - External debt dynamics are highly sensitive to growth shocks, current account deterioration, and reductions in FDI. - Gross external financing needs remain large (e.g., 50.4 percent of GDP in 2015 under baseline). *Source: IMF staff (Annex II and related text from the IMF country report).* ### 1. The unresolved conflict in Eastern Ukraine has taken a significant toll on our economy, ### _cr1569 - 1. The unresolved conflict in Eastern Ukraine has taken a significant toll on our economy, ### Recent impact and program context - The unresolved conflict in Eastern Ukraine caused a large shock to the industrial base and financial markets, generating significant balance of payments pressures and holding back macroeconomic stabilization. - The large exchange rate depreciation since early 2014: - raised public debt, - weakened bank balance sheets, - eroded gains toward cost recovery in Naftogaz. - Despite the difficult environment, all performance criteria (PC) for end-September and most fall benchmarks were met (except the standard continuous PCs on exchange restrictions and multiple currency practices), and the government kept the budget on track through December 2014. Other end-December targets were not met due to intensified capital outflows after escalation of the conflict. - Economic activity: - contracted by 6.9 percent in 2014, - projected to decline by 5.5 percent in 2015, - expected to return and gradually strengthen, reaching 4 percent over the medium term (2016–18). ### Program request and financing - Ukraine requests a new four-year extended arrangement under the Extended Fund Facility (EFF) in an amount equivalent to SDR 12.34806 billion (900 percent of quota and about US$17.5 billion). - Intention to cancel the 2014–16 Stand-By Arrangement immediately before approval of the new extended arrangement. - International partners have committed additional funds to help fully finance the proposed program. - Consulting with holders of public sector debt aimed at improving medium-term debt sustainability. - Request to retain temporarily the exchange restrictions and multiple currency practices inconsistent with Article VIII Sections 2 (a) and 3 due to balance of payments difficulties. ### Macroeconomic projections and key indicators - Inflation: - reached 25 percent at end-2014, - projected to remain broadly similar in 2015, - expected to decelerate rapidly, dropping to single digits in 2016 and to 5 percent by 2018. - External sector: - exports projected to decline in 2015 due to crisis effects, deteriorating terms of trade, and declines in tourism and transportation receipts, - current account deficit projected to stabilize to around 1–1½ percent of GDP in 2016–18, - reserves expected to be gradually replenished to comfortable levels over the medium term. - Monetary policy stance: anticipate maintaining a positive real policy rate on a 12–18-month forward-looking basis. ### Monetary and exchange rate policy (policy actions and targets) - Objectives: - low and stable inflation within a flexible exchange rate policy, - gradual rebuilding of FX reserve buffers, - single-digit inflation by end-2016. - Operational framework: - monetary aggregate targeting regime using NBU’s NIR and NDA as operational targets and base money as intermediate target, - open market operations as the principal tool; quantitative PCs and indicative targets referenced (Table 2 in source). - Reserve rebuilding and FX operations: - FX sales by the NBU limited to facilitating external payments by the central government and critical energy imports by Naftogaz and Energoatom for amounts factored into the program (TMU, Section I, Table C), - abolish regulations preventing Naftogaz from purchasing foreign exchange from the market, - Ministry of Finance to seek rollover of government domestic FX debt liabilities by offering suitable interest rate and maturity instruments, - coordination between the Debt Management Unit and NBU units to support reserve targets, - discussions with the People’s Bank of China on extension and use of existing swap line. - Administrative measures and capital controls: - 2015 budget introduced a temporary surcharge on imports (with exceptions for energy and pharmaceuticals), effective February 26, 2015 and based on Article XII of the GATT (1994); committed to remove by end-2015 or earlier if WTO does not approve, - committed to removing other administrative measures, including exchange restrictions and MCPs; by May 15, 2015 prepare a plan for removal conditioned on sufficient progress, - capital controls will remain effective for the time being and may be tightened temporarily if downside risks materialize. - NBU institutional reforms and governance: - draft legislative amendments to the NBU Law in consultation with IMF staff by end-February 2015; parliamentary approval is a structural benchmark for end-April 2015, - transform the NBU Board into an Executive Committee (Governor and Deputy Governors) to formulate and implement monetary and exchange rate policy and regulate banking, - strengthen NBU Council oversight, including responsibility for internal controls and risk management and authorizing an Audit Committee, - strengthen personal autonomy of NBU Council members and Deputy Governors via appointment/dismissal procedures and a new Code of Conduct, - uphold NBU financial autonomy by keeping its administrative budget in line with the Law on the National Bank, - profit distribution rules to build general reserves to reach 4, 7, and 10 percent of monetary liabilities at end-2014, 2015, and 2016 respectively, - in 2015 profit distribution to the government, based on 2014 financial operations, is expected to be at least UAH 60 billion, pending verification from the NBU’s financial audit for 2014, - limit disbursement of the 2014 profit distribution, ahead of completion of audit, to a maximum of 25 percent of the projected annual amount, - amend the Budget Code to prevent inclusion of advance profits in annual budgets. - Organizational and communications reforms at NBU: - separate monetary policy formulation from implementation and establish a Monetary Policy Committee to advise the Executive Board, - strengthen communications and public accountability, publish inflation and financial stability reports, and coordinate public communications with the Ministry of Finance. - Inflation targeting: - continue capacity strengthening for future adoption of inflation targeting when macro-financial conditions permit, - discontinue past practice of using Cabinet of Ministers’ projections for monetary policy targets. ### Financial sector policies (objectives and measures) - Central objective: steady and full rehabilitation of the financial system so sound financial institutions can support credit and sustainable growth. - Four fronts of work: - upgrade regulatory and supervisory framework to identify and reduce related-party lending, - update banking capitalization strategy, likely requiring additional private and public resources, - enhance asset recovery and official investigations of bank failures, - strengthen bank capacity to resolve bad loans. - Restore public confidence in the banking system to resume normal funding and intermediation for the real economy. - Bring financial surveillance, lending policies, and internal governance of all banks up to international best practice. ### Fiscal and structural reform agenda - Fiscal policy: - short- and medium-term fiscal policies to strengthen fiscal sustainability while making space for social protection spending and infrastructure investment, - fiscal adjustment based on expenditure consolidation to restore debt sustainability with high probability, supported by donor financing and a debt operation to alleviate near-term debt service burden. - Structural reforms (frontloaded, ambitious, and comprehensive): - eliminate Naftogaz’s deficit by 2017 and restructure Naftogaz, - governance reforms including anti-corruption and judicial reform measures, - deregulation and tax administration reforms to improve the business climate, - state-owned enterprise reforms to reduce fiscal risks and strengthen corporate governance, - reforms aimed at strengthening investment, attracting higher investment, and enhancing competitiveness to boost medium-term growth potential. - Program monitoring and transparency: - Government believes MEFP policies are adequate to achieve program objectives but will take additional measures if appropriate and consult with the IMF in advance of revisions, - provide IMF staff with requested data and information for monitoring, - consent to IMF publication of the letter, the MEFP, the Technical Memorandum of Understanding (TMU), and accompanying Executive Board documents. *Source: Attachment I. Ukraine: Memorandum of Economic and Financial Policies (excerpts) — IMF staff document provided in content unit.* ### 13. We are working toward ensuring proper identification, monitoring and, where ### _cr1569 - 13. We are working toward ensuring proper identification, monitoring and, where ### Related-party lending identification, monitoring, and unwinding - Legislation - Approve legislation to introduce unlimited liability of bank owners on losses arising from loans granted directly or indirectly to the benefit of bank shareholders holding 10 percent or more (including shareholders acting in concert) of total voting shares as of end-2014 (prior action). - Legislation to furnish the NBU with powers to presume the existence of economic (related) relationship between banks and borrowers on the basis of objective criteria. - Lending rules - By end-March 2015, in consultation with IMF and World Bank staff, pass legislation and revise NBU regulations on related parties to close loopholes that may leave room for the circumvention of lending limits to insiders. - Bank reporting of related loans - By end-May 2015, as instructed by the NBU and on the basis of end-March 2015 data, the 10 largest operating private banks will submit reports of related party exposure according to the new legal and regulatory framework. - The next 10 largest banks will submit their reports by end-July 2015. - All other banks will report by end-September 2015. - Prudential review of bank reports (top 10 banks) - By end-September 2015, the NBU, with technical support of the four largest international accounting firms (with teams led by foreign partners) and on the basis of terms of reference agreed with the IMF and WB staff, will complete comprehensive reviews of the 10 largest banks’ related party exposure reports. - Review steps: - Check whether the banks have reported all loans to individuals and legal entities above 1 percent and 3 percent of bank equity, respectively, that meet the revised related party criteria. - Verification by the auditors that banks’ information security frameworks (policies, protocols and processes) ensure the integrity and confidentiality of bank records, as defined in the agreed terms of reference. - NBU’s notification of the banks of any identified discrepancies based on steps (i) and (ii) no later than end-July 2015 (structural benchmark). Banks will be given until end-August 2015 to prove otherwise. The NBU will then review the banks’ responses and issue its final report to each bank, listing all related party loans and the amounts by which they exceed limits by end-September 2015. - Prudential review timetable for remaining banks - NBU will complete reviews of the next 10 largest banks by end-December 2015 and reviews of all other banks by end-April 2016. - A more detailed underlying timetable for the latter group of banks will be agreed with IMF staff no later than end-May 2015. - Bank related party unwinding action plans - By end-October 2015, each of the top 10 banks will submit to the NBU an action plan to unwind above-limit related party exposures within 3 years. The NBU and the banks will reach agreement on these plans by end-November. - Unwinding plans for the next 10 largest banks should be agreed by end-February 2016 and by end-June 2016 for the remaining banks. - Unwinding plans should include: - credible quarterly schedules; - minimum first payments or related exposure reductions of no less than 5 percent of excess loans to insiders; - proper loan collateralization; - securing non-revocable written guarantees issued by qualified shareholders controlling (more than 10 percent of votes as regards to all of their related loans). These guarantees should remain in place until the bank is fully compliant with the legal and regulatory related lending framework. - Details on time schedules for plan implementation will be agreed with staff no later than end-May 2015. - NBU monitoring and enforcement - NBU will closely monitor implementation of agreed unwinding plans, including by quarterly assessing financial information submitted by the key related businesses that owe the banks money to follow their debt repayment plans and use of cash flow. - If a bank has two breaches to the agreed unwinding plan, this will lead to cancellation of the plan and bank resolution. - NBU Monitoring Unit - Establish a specialized group to identify all major economic groups as well as those related to banks and monitor their structure and credit exposure on a continuous basis. - With technical assistance from the IMF and the World Bank, by end-September 2015 plan to have this unit fully operational and with an action plan for the following 12 months, which would include the mapping of the largest 10 industrial and financial groups by end-December 2015. ### Additional supervisory and regulatory measures - Establishment of a credit registry at the NBU. - Full adoption by banks of IFRS for financial reporting in the second half of 2015. - A review of the NBU supervisory model. - Improving financial performance and monitoring of majority state-owned banks, with a comprehensive strategy to be developed by September 1, 2015 with IMF technical assistance. - Legal protection for bank supervisors; specific measures to be developed with IMF technical assistance. ### Banking capitalization, resolution strategy, and recapitalization requirements - Recapitalization requirements (based on 2014 diagnostic studies) - 9 of the largest 15 banks are required to submit credible and binding recapitalization plans. - Require a minimum contribution of 25 percent from these banks through cash injection or debt-to-equity swaps by end-January 2015. - Require full implementation of the recapitalization plans by end-June 2015. - Recapitalization plans for the next largest 20 banks have been approved and will be completed by end-February 2015. - Temporary prudential restrictions for non-compliant banks (provided they have not been declared problem banks by the NBU) - zero growth ceiling on net lending; - prohibition on any new lending to related parties; - prohibition on repayment of related deposits; - appointment of a senior NBU observer to the executive board and key managerial committees of the bank. - State intervention and bail-in mechanics - Banks that do not comply with their recapitalization plans will be resolved. - If bank owners of systemic banks are unwilling or unable to recapitalize their institutions, the bank will be intervened and either resolved or recapitalized with state funds, as prescribed by the DGF law and the law on measures to facilitate bank capitalization and restructuring. - Prior to state recapitalization, the DGF authorized officer will bail-in related deposits (mostly related to top management and shareholders holding above 10 percent of voting rights), subordinated debt, and unsecured non-deposit creditors up to 25 percent of regulatory capital so that the state becomes the controlling shareholder with a participation of 75 percent or more of the voting rights. - The budget stands ready to provide all justified funds necessary for bank restructuring and recapitalization. - Timetable to address additional capital needs - By end-July 2015 and end-September 2015 on the basis of end-2014 and end-March 2015 data, respectively, update the diagnostic exercises for all operating banks among the top 10 and 10 subsequent banks, respectively, to identify additional losses associated with the conflict in the East and the downgraded economic outlook through 2017. - Updates to be made on the basis of terms of reference agreed with IMF and WB staff by end-March 2015, and include: - Asset quality review: To be completed on the basis of the regulation on credit risk assessment and with the participation of NBU inspection teams. - Stress test: On the basis of the program’s baseline macro scenario and using NBU internal modeling forward looking losses through 2017 will be identified. - Review will be closely monitored by a Steering Committee; the IMF and the WB will appoint independent observers to this committee. - If the exercise reveals a bank undercapitalization with a CAR below 10 percent, the bank will be asked to present credible plans by end-August 2015 and end-October 2015 for the group of 10 top and 10 subsequent banks, respectively, to meet: - 5 percent (tier 1 capital of 4 percent and tier II capital 1 percent) minimum capitalization level by end-January 2016; - 7 percent (tier 1 capital of 6 percent and tier II capital 1 percent) by end-December 2017; - 10 percent (tier 1 capital of 7 percent and tier II capital 3 percent) by end-December 2018. - Should the exercise find insolvency in certain banks, these banks must be brought into solvency (positive equity) by end-August 2015 and end-October 2015 for the group of 10 top and 10 subsequent banks, respectively. ### Enhancing asset recovery and official investigations of bank failures - Extend timeframe to complete bank liquidation - By end-May 2015 pass legislation to allow the DGF to complete bank liquidation within five years (up from the current 3 years). - Assess options to improve asset recovery - With technical assistance from the World Bank, by end-June 2015 complete an assessment of options available to maximize recovery value and develop an action plan with key performance indicators to assess DGF progress in asset recovery. - Initiate due diligence investigations (forensic audits) of failed banks - By end-February 2015 complete the terms of reference to guide due diligence of banks under temporary administration. - Tender process for selection of firms responsible for the due diligence investigations of the first two cases will be initiated by end-April 2015 with a view to launch investigations by end-June 2015. - In case of discovery of fraud and other illegal action by bank managers or owners, DGF will report it to law enforcement agencies. - Will approach the donor community for funds to support the audits. ### Strengthening bank capacity to resolve nonperforming loans (NPLs) - Legislation - With technical assistance from the IMF, by mid-May 2015 identify a set of reforms needed to strengthen the legal framework related to private debt restructuring, covering foreclosure procedures, corporate and personal insolvency and tax incentives. - By end-July 2015 commit to submit to parliament legislation to introduce such reforms. - Out-of-court mechanism - With technical assistance from the EBRD, in consultation with Fund staff, and in close cooperation between the NBU, MoF, DGF and banks, by end-June 2015 establish a coordinated out-of-court restructuring system in line with international best practice including the INSOL principles and the Istanbul approach. - This could include setting up a Coordination Secretariat, Arbitration Council function and development of all relevant regulations. - FX mortgages and Code of Conduct - Remain committed to supporting a voluntary negotiation process between borrowers and banks for the restructuring of foreign currency denominated mortgage loans serviced by struggling but still performing borrowers. - The state and the NBU should not interfere in bilateral negotiations while ensuring fair process. Should a law imposing mandatory conversion of foreign currency mortgages into hryvnia be passed, the president will veto its enactment. - On the basis of NBU existing guidelines on loan in arrears and international best practice, with technical assistance from the IMF, by end-March 2015 the NBU will issue a Code of Conduct to guide negotiations between borrowers in difficulty and banks, establish debt restructuring guidelines, and an appeal process. ### Fiscal policy: medium-term consolidation and budget measures - Fiscal strategy - Pursue an expenditure-led consolidation to target a smaller and more efficient government and make the tax system growth-friendly, transparent, and equitable. - Bring Naftogaz to financial health and eliminate government subsidies to the company by 2017. - Limit other debt creating operations to the strictly needed, while providing adequate government resources to support the rehabilitation of the banking system. - External creditor support necessary to reach the debt target of below 71 percent of GDP by 2020. - Program targets and trajectories - Combined general government-Naftogaz balances: - Reduce the combined general government and Naftogaz deficit from 10.3 percent of GDP in 2014 to 7.4 percent of GDP in 2015, and take any measures necessary to achieve it. - Continue to reduce the combined deficit toward 2.6 percent of GDP by 2018. - General government fiscal deficit: - Headline deficit will fall from 4.6 percent of GDP in 2014 to 2.6 percent of GDP by 2018. - Primary balance will move from a deficit of 1.2 percent of GDP in 2014 to a surplus of 1.6 percent of GDP by 2018. - Primary expenditure will fall from 43 percent of GDP in 2014 to 39.2 percent of GDP by 2018. - Naftogaz balances: - Naftogaz’s deficit will improve from 5.7 percent of GDP in 2014 to 3.1 percent of GDP in 2015 and 0 percent of GDP by 2017 and thereafter. - Starting with the 2017 budget, any government support to Naftogaz will be in line with ESA/GFSM accounting standards, where government support to state-owned enterprises is shown as a current subsidy. - 2015 budget and measures - 2015 budget passed in December 2014 targeted an overall deficit of UAH 65 billion. - Expenditure-side measures: - Kept current nominal levels of minimum and maximum pension benefits until December 1, 2015. - Adjusted pension replacement rate for special pensions from 80 percent in 2013 and 70 percent in 2014 to 60 percent in 2015, except pensions for military pensioners. - Restrained spending on goods and services; eliminated price subsidies to the coal-mining industry. - Committed to maintain until December 1, 2015 the minimum and basic wage for the first tariff grade unchanged at the level of December 2013. - As a result of these actions and staff optimization, the wage bill of the budgetary sector (excluding the military) is maintained at the 2014 level. - Revenue-side measures: - Reduced distortive and nuisance taxation through elimination of various small taxes and fees and abolished the foreign exchange transaction tax for non-cash transactions. - Expanded the base for property taxation and introduced a new excise on retail sales at 5 percent. - Introduced a new annual assessment tax on luxury vehicles. - Reduced the social security contribution rate by 60 percent for those entities who significantly increase their reported overall wage bill and raise average wages. - Increased progressivity in the personal income tax, expanded the base to include income from capital gains and increased the associated tax rate from 15 percent to 20 percent. - Reduced the taxable threshold for pension benefits from ten to three minimum wages. - Extended the effective period of levying the military tax on income until parliament decides that the military forces reform is complete. - Compliance and administration - Amended transfer pricing legislation extending the scope of transfer pricing rules. - Introduced electronic VAT administration. - Mandate cash registers for individual entrepreneurs starting July 1, 2015. - Eliminated the discretion for large taxpayers to choose a tax office to manage their tax affairs. Currently, almost 60 percent of large taxpayers are serviced outside the Large Taxpayer Office (LTO). - By end-2015, transfer all taxpayers meeting large taxpayer criteria to the LTO (structural benchmark). *International Monetary Fund — Ukraine program document excerpt* ### 23. To achieve our 2015 fiscal targets and put our medium-term fiscal adjustment on a ### 23. To achieve our 2015 fiscal targets and put our medium-term fiscal adjustment on a ### 2015 supplementary budget measures and prior action - Prior action: Parliamentary approval of a 2015 supplementary state budget law and a package of related tax and expenditure legislation consistent with the program deficit ceiling of UAH 78.2 billion for the general government. - Major amendments with budget impact: - Social assistance: - Increase utility subsidies to households to mitigate the impact of retail energy price increases on the most vulnerable, costing up to an additional UAH 12.5 billion. - Already in the budget: introduction of income means-testing of households eligible for various benefits, and reduction of unaffordable social insurance and non-insurance payments. - VAT, profits, and royalties: - Prices of domestically produced gas by Naftogaz’s subsidiary Ukrgazvydobuvannya (UGV) will be increased by 355 percent. - Part of additional UGV revenue to raise investment in domestic gas extraction; remainder collected by the government as VAT, profit, and royalty taxes to offset additional energy-related social spending. - Wage bill: - Reduce the number of budget-paid employees by 3 percent over the course of 2015, including a 20 percent reduction of the civil service workforce. - Begin process on March 1, 2015, and aim to complete by end-September 2015. - Repeal the law limiting wages to government and NBU employees to 7–10 minimum wages; offset the impact of repeal within the budgeted wage bill. - Pensions: - Reduce benefits for working pensioners and limit early retirement options by gradually (6 months a year) increasing the retirement age by 5 years and the qualified period of service by 5 years for a number of professions eligible for early retirement (as defined in the TMU Annex), effective April 1, 2015. - Increase in qualified period of service affects both men and women; increase in retirement age is only for women. - These measures will bring total savings of not less than UAH 1.6 billion already in 2015. - Government will make legal provisions and ensure adequate funds for pensioners who remain in the territories outside of government control and did not receive pension benefits in 2014, were these to be requested by them. ### Medium-term fiscal consolidation (2016–18) — objectives and anchors - Objective: Continue gradual expenditure-based fiscal consolidation to reduce imbalances, reduce the size of government, build confidence, and facilitate growth. - Adjustment anchors and focus: - Pension reform as a key adjustment anchor. - Additional steps in public sector wages, goods and services (procurement). - Strengthening social assistance to those most in need. - Revenue-side: drive for a more efficient and equitable tax system, shift from direct to indirect taxation, investment-friendly natural resource taxation, simplify tax system, lower tax burden, limit tax evasion, eliminate tax exemptions, encourage formalization. - Specific measures and benchmarks to be elaborated during the program. ### Expenditure reforms (detailed) - Parametric pension reform: - Submit to parliament a revised pension law no later than September 15, 2015 to become effective by January 1, 2016. - During the program, index pensions (including civil service and special pensions) to prices and lower the threshold for pension benefits’ income tax liability. - Seek to gradually unify special pensions’ calculation rules with those of the general system. - Size and efficiency of government: - Goal of lowering the wage bill to around 9 percent of GDP over the medium term. - Review salary structures to ensure competitive remuneration, especially at managerial level of central government. - Design and implement health and education sector reforms to improve outcomes with more efficient use and mix of resources, yielding budget savings. - Healthcare: - By end-March 2015, submit to parliament draft legislation to: - Change public financing of secondary healthcare from hospital bed to service-based financing and for primary healthcare from infrastructure-based to capita-based financing. - Allow medical facilities to legally generate own revenue. - Change public procurement regulation to allow purchasing medicines and medical supplies through direct, multi-year procurement involving UN based organizations. - Education: - Reforms to focus on: - (i) rationalization and reduction of higher education institutions from 802 to 317; - (ii) streamlining the network of vocational schools; - (iii) streamlining the general secondary school system, reducing the number of schools by 5 percent by consolidating small schools and reducing employment accordingly; - (iv) reducing public appropriation for training specialists depending on needs of the economy and demographic trends. - These reforms will enable reduction in expenditures by at least UAH 300 million in 2015 and thereafter. - Submit by end-May 2015 draft legislation to parliament with objective to enact necessary legislation by September 1, 2015 and complete reforms during 2015–16. - Social assistance: - Improve design of existing social assistance programs (category-based for housing utilities; means-tested subsidies for housing utilities; new tariff compensation scheme). - Prioritize the general guaranteed minimum income (GMI) program as better targeted to low-income households. - Investment: - Increase and maintain capital investment levels from 1 percent of GDP in 2014 to over 3 percent of GDP by 2018 to fund reconstruction and long-term infrastructure development. ### Tax policy reforms - Social security contributions: - Continue reducing the social security contribution wedge to encourage de-shadowing of wage payments. - Pace of reform linked to progress in reducing pension spending; outcome of 2015 legalization efforts will inform further direction. - Agriculture VAT: - Bring the agriculture sector fully under the general VAT regime, effective January 2016. - Personal income tax: - Continue measures begun in 2015 to broaden the base and further increase progressivity; include steps to better detect and tax income and wealth of high net worth individuals, drawing on IMF technical support. - Property taxes: - Gradually eliminate exemptions and raise tax rates to strengthen own revenue base of subnational governments. - Extractive industry taxation: - Introduce a new fiscal regime for extractive industries from 2016 transitioning to international best practice, including a review of current level of royalties. - Prepare and submit relevant amendments to the tax code by July 1, 2015 and strengthen administrative capacity in this area with IMF technical expertise. ### Revenue administration, public financial management, and benchmarks - Revenue administration reform: - Prepare, in consultation with IMF staff, a revenue administration reform plan by end-April 2015 to overhaul the State Fiscal Service (structural benchmark). - Plan to include governance and institutional reforms: streamline regional offices, remove underperforming officials, modernize and computerize customs system, strengthen governance, and subordinate the State Fiscal Service to the Ministry of Finance. - Implementation of new arrangements expected to start from January 2016 (structural benchmark). - Continue improving tax dispute resolution framework and collection of tax arrears; ensure tax arrears, excluding Crimea, Donetsk, and Luhansk, do not increase. - Strengthen administrative capacity in application of transfer pricing legislation. - Compliance with social security contributions: - Undertake measures to strengthen compliance, including directing more resources to fight evasion as soon as April 2015. - Public finance management: - (i) Strengthen medium-term budget planning by introducing medium-term fiscal framework and expenditure ceilings on key spending units. - (ii) Develop design features of the medium-term budget framework and prepare relevant amendments to the Budget Code to introduce a full-fledged MTBF from 2018. - Cash management: - (i) Review use of all central government commercial bank accounts, including foreign currency accounts, and close unnecessary ones. - (ii) Establish a cash planning unit in the Ministry of Finance or State Treasury. - (iii) Reduce volatility of the Treasury Single Account through alignment of major receipts and expenditure. - Budget execution: - (i) Introduce commitment control system to the budget execution framework. - (ii) Eliminate distinction between protected and unprotected items. - Debt ceiling: - Revisit recent amendments, aiming to introduce escape clauses for deviation from statutory debt limit, and re-insert the 5 percent limit on the issuance of government guarantees. ### Public sector financing and debt operation objectives - Intend to consult with holders of public sector debt on a debt operation to improve medium-term debt sustainability; financial and legal advisors hired (prior action). - Program objectives guiding debt operation: - (i) generate US$15 billion in public sector financing during the program period; - (ii) bring the public and publicly guaranteed debt/GDP ratio under 71 percent of GDP by 2020; - (iii) keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025. - Restructuring expected to be based on program baseline macro framework applicable at time of launch; expected to be finalized by time of the first review. ### Energy sector policy — objectives and specific measures - Overall goals: - Bring Naftogaz to profitability by raising gas and heating prices to cost recovery levels based on international gas prices, strengthening governance, and restructuring the company. - Enhance energy-related social safety net for the most vulnerable. - Undertake structural reforms to attract capital investment, increase energy efficiency, and foster energy independence. - Naftogaz deficit reduction targets: - Reduce Naftogaz’s deficit to 3.1 percent of GDP in 2015 and eliminate it by 2017. - End-user price hikes and timing: - Complete process of increasing gas prices to levels consistent with full import parity by April 2017. - First step: reduce household gas price tiers from four to two and energy regulator to adopt and officially publish a decision to raise gas prices for households by 285 percent on average. - Effective April 1, 2015 (prior action): price of UAH 3600/tcm for Tier 1 (below 200 m3 a month for consumers that use gas for heating in the cold season) and UAH 7187/tcm for Tier 2 (above 200m3 a month as well as gas used only for cooking and hot water). - This will allow bringing the price Naftogaz receives to not less than UAH 2200/tcm without VAT for Tier 1 and not less than UAH 5100/tcm without VAT for Tier 2. - Abolish two-tier pricing and raise household price as needed to reach 75 percent of import parity in April 2016 and 100 percent in April 2017; until then, prices will not be adjusted downwards. - Once full import parity is reached, adopt a new methodology linking retail gas prices to movements in import gas prices and exchange rate on a quarterly basis. - Prices paid to Naftogaz subsidiaries that extract gas will be gradually increased to the equivalent of at least $150/tcm by April 2017. - Ensure energy pricing frameworks provide for covering all investment costs in full. - If retail price components not related to Naftogaz rise, retail price will change to accommodate them rather than the price Naftogaz receives. - Retail heating prices: - Energy regulator to adopt and officially publish decision to raise retail heating prices to households by 67 percent on average, to UAH 625/gcal, effective April 1, 2015 (prior action). - This will allow bringing the price Naftogaz receives to not less than UAH 1793/tcm, excluding VAT and mark-up tax. - Heating prices to increase to 75 percent of level consistent with gas priced at full import parity in April 2016 and to 100 percent in April 2017; until then, prices will not be adjusted downward. - Thereafter adopt a new methodology linking retail heating prices to quarterly movements in import gas prices and exchange rate. - Industrial gas prices: - Continue to adjust to reflect exchange rate and gas import price movements. - Naftogaz structural reform measures: - Collections: - Submit to Parliament legislative amendments to improve Naftogaz collection (prior action) and have them adopted by Parliament by March 31, 2015 (structural benchmark). - Amendments to include lifting moratoria (Law 2711-IV/2005 and Law 2864-III/2001) protecting energy and other companies from enforcement proceedings and disconnecting non-compliant customers from gas supply grid. - Develop regulations on application of the law with IMF technical assistance. - Existing receivables over 2 percent of GDP at end-2014 targeted for increased collection. - Independent audit of receivables: - Undertake an independent audit of all Naftogaz receivables by June 30, 2015 (structural benchmark). - Audit objective: identify debtors, size of debts, reasons for persistence, and weaknesses in internal collection procedures; seek external financing from international partners. - Audit: - Complete full IFRS audit of Naftogaz by reputable auditors for 2012 and 2013 on a consolidated basis by end-March, 2015, and for 2014 by end-July 2015. - Naftogaz restructuring: - Support restructuring to reduce losses from governance issues and raise social acceptance of cost-recovery prices. - Gas market law: - New draft gas market law presented to Cabinet of Ministers; framework to establish third party access, regulator approval of methodologies and tariffs, and free competition through price liberalization. - Establish mechanisms for unbundling gas infrastructure management from gas production and supply. - Seek Parliamentary approval of the law by end-April 2015 (structural benchmark). - Gas sector reform and implementation plan: - In collaboration with World Bank staff, Ministry of Energy and Coal Industry and Naftogaz finalizing plan including unbundling Naftogaz’s main business lines (transmission, storage, gas sales) and improving transparency via audits of distribution companies and metering. - Cabinet of Ministers to adopt plan by end-February 2015. - Promoting competition: - Emergency measure (November 2014) obliging over 170 companies to purchase natural gas exclusively from Naftogaz will be allowed to lapse at end-February; no intention to reactivate it. - Energy SOE reform: - With EBRD assistance, improve corporatisation and corporate governance of key state companies (including NEC Ukrenergo, NAEC Energoatom, NAK Naftogas and its subsidiaries) based on OECD Guidelines. - Prepare to privatize Centrenergo generation company and other key energy producers. *Source: _cr1569 - 23. To achieve our 2015 fiscal targets and put our medium-term fiscal adjustment on a* ### 29. Eliminating energy subsidies requires an effective strategy for protecting lower- ### 29. Eliminating energy subsidies requires an effective strategy for protecting lower- ### Energy subsidy reform and social protection - Recent reforms used means testing of energy privileges, elimination of duplication, and creation of a new energy compensation program for the poorest; further reform is needed to cope with the expected large increase in applicants and contain the fiscal cost. - Commitments: - Merge the energy privileges program and the energy compensation program into an expanded energy housing utilities subsidy program by transferring energy compensation beneficiaries to the subsidy program. - Prepare a plan for the merger by March 31, 2015 and discuss it with IMF and World Bank staff. - Merge to be completed by May 31, 2015. - Revise the benefit formula in consultation with IMF and World Bank staff to provide strong incentives for energy efficiency while ensuring poverty relief. - Allocate sufficient fiscal and administrative resources to prepare for an influx of new beneficiaries given the large upcoming tariff increases. - Over the medium term, integrate the energy bill assistance program as a component of the broader social safety net system built around a reformed and affordable General Minimum Income (GMI) program; set out a timeline for transition to the new system by 2017. - Payments system: revise billing methodology to allow bill payments to be smoothed over the year—with payments for the previous heating season completed before the beginning of the new one—to avoid undue strain on households and maintain payments compliance. - Information campaign: conduct extensive public information campaigns to explain the tariff increases, how they will help improve energy service provision, energy independence, and the finances of Naftogaz, and the availability of the new energy subsidy programs. ### Energy efficiency and metering (paragraph 30) - Problem: Inefficiencies result in large energy losses at the production, distribution and household consumption stages. - Metering status and targets: - As of mid-2014, metering for heat was only at 36 percent. - By end-2016, seek to achieve universal gas and heat metering, make it compulsory to bill based on meter reading where meters exist, and move to universal consumption-based billing. - Measures: - Step up efforts to install gas and heat meters, especially in low-consumption households and for heating. - Legal and institutional reforms to specify responsibilities for expanding the use of meters and individual heat substations and to facilitate financing of these investments. - With IFC and USAID assistance, make legislative changes to allow for investment in multi-housing apartment buildings where the majority of heating losses are generated. ### Governance, transparency, and business climate (paragraphs 31–34) - Reform strategy ratified by Parliament in October for 2014-2017 focusing on: (i) overhauling governance by reducing corruption, strengthening law enforcement and reforming the judiciary; (ii) improving the business climate; and (iii) reforming the public sector and political campaign financing. - By end-February, publish the program to implement the October reform strategy. - Anti-corruption and AML measures: - Adopted a set of laws on anti-corruption and anti-money laundering (AML) last October; progress toward establishing a strong anti-corruption investigative agency; amendments to the AML law and the criminal code have strengthened tools to fight money laundering. - Commit to further strengthening the anti-corruption legal framework and prioritizing its implementation. - Specific NAB (National Anti-corruption Bureau) legislative and establishment measures: - Amend the NAB Law to ensure: external oversight, jurisdiction and information access, staff integrity, and legal consistency. - External Oversight: provision for an independent external oversight process with an annual published report; oversight to be conducted by a panel of respected experts with international experience. - Jurisdiction and Information: NAB will be able to investigate all high-level officials, including former Presidents; empowered to obtain all relevant information, including information covered by banking secrecy, without restriction or court order requirement. - Staff Integrity: ensure competitive and stable remuneration for the Director and personnel; applicants and holders consent to thorough background checks (criminal records, analysis of disclosures of assets beneficially owned and of potential conflicts of interests). - Legal Consistency: ensure the NAB legal framework remains consistent with the specifications of the end-October structural benchmark and with the Constitution. - Establish the NAB by end-April 2015 (structural benchmark). - Steps: (i) select the NAB Director; (ii) provide an adequate budget for the NAB to organize and perform its functions; (iii) provide secure and appropriate premises for NAB’s central office. - Enhance Ukraine’s AML framework by end-June 2015 (structural benchmark): - NBU to amend AML/CFT regulations to implement legal requirements related to domestic politically exposed persons (PEPs). - FIU to assist financial institutions and other reporting entities in identifying domestic PEPs via guidance and training. - Improve domestic cooperation arrangements among NBU, FIU, and NAB, including reporting procedures and information sharing consistent with FATF standards. - Strengthen asset disclosure process: - By end-March 2015, revise the legal framework to ensure asset disclosures for high-level officials subject to NAB’s jurisdiction include information on beneficial ownership and control of any funds or other assets (as defined by the FATF). - Ensure NAB can use its powers to ensure the reliability of these asset disclosures at any point in time. - Prohibit high-level officials from receiving any gifts and advantages other than of very low value, and from receiving any salary or emoluments other than those related to their official functions or that are allowed by the Constitution. - Additional anti-corruption measures: tackle needed reforms of the Prosecutor General’s Office and establish a robust and effective institutional framework for preventive anti-corruption measures. ### Regulatory and investor protection reforms (paragraphs 33–34) - Streamline regulatory framework: - Identify excessive regulatory barriers in consultation with civil society; adopt an action plan by the Council of Ministers by March 11, 2015. - Publish the approved action plan together with a background note explaining prioritization and impact assessment. - Ministry of Economy and State Regulatory Service (SRS) to monitor implementation and publish quarterly progress reports within 15 days of the end of the quarter beginning April 15, 2015. - SRS to be responsible for regulatory impact assessment (RIA) of new regulatory proposals; SRS, in consultation with the WB, to create and implement a proper RIA mechanism. - Improve investor protection: - Draft law on investors’ protection prepared with World Bank staff aiming to: - introduce the minority shareholder’s right to bring a suit to indemnify for damages in the company’s interests; - introduce disclosure requirements of transactions for which there is interest; - introduce requirement to invite an independent auditor to assess transaction compliance with regular market conditions. - Pass the law by end-March, 2015. - Reduce number of inspection agencies. ### Judiciary and legal enforcement reforms (paragraph 35) - Reform areas: (i) judicial reform; (ii) financial efficiency; and (iii) effective enforcement of commercial claims. - Measures and timelines: - Judiciary and Status of Judges: - Parliament is expected to adopt a Law on the Judiciary and the Status of Judges during February 2015. - By end-March 2015, submit the Law to the Venice Commission of the Council of Europe for review and opinion. - By end-July 2015, complete preparation of a concept note assessing potential consolidation of the superior courts (jurisdiction, case process, personnel, budget, buildings). - Court Fees: - By end-May 2015, adopt a Law on a selective increase of court fees aiming to double court fee revenues in real terms within 12 months (structural benchmark). - Order of Payment Procedure and Garnishments: - By end-August 2015, adopt a Law strengthening Code of Civil Procedure provisions on Order for Payment for domestic transactions and on garnishment of bank accounts (structural benchmark). - Amend Order of Payment provisions to expand claims covered, streamline evidence required, and use standardized forms. - Address garnishment bottlenecks: definitional issues, locating debtor bank accounts, service of process, adherence to strict timelines, and bank liability for non-compliance. - Complete an implementation plan for the new provisions by end-August 2015; law to take effect according to a schedule allowing assessment and mitigation of risks. - Private Enforcement Profession: - Adopt a Law establishing a profession of private enforcement agents by end-September 2015, specifying jurisdiction, professional standards, oversight, disciplinary mechanisms, fee structure, and access to registers and records with reference to CoE standards. ### State-owned enterprises (SOEs) reform (paragraph 36) - Context and scale: - Over 3,300 central government controlled SOEs in Ukraine, of which just under two-thirds are operational. - In 2014, transfers from government to the SOE sector amounted to about 2½ percent of GDP (excluding the large transfers to Naftogaz), while dividends were less than 0.2 percent. - Objectives: enhance financial viability, reduce fiscal burden, separate ownership and regulatory functions of the state. - Near-term measures and timelines: - Fiscal risk assessment: - Ministry of Economy and Ministry of Finance to prepare by end-April a statement of fiscal risks emanating from SOEs to include: an inventory of enterprises that pose the largest fiscal risks and identification of the top 30 SOEs with the largest fiscal risks among them; an assessment of the size and probability of realization of these risks; and proposed mitigating actions. - Design and implement a monitoring and reporting system (structural benchmark). - Oversight: - By end-February, assign a unit at the Ministry of Economy responsible for preparing reform strategy; preparing an inventory of SOEs; and developing and implementing a fiscal risk management system. Ensure adequate resources for proper functioning of the unit. - Reform strategy: - Government to adopt, by end-May 2015, a strategy in consultation with IMF and WB to reform the SOE sector, including timeline for improving budgetary oversight, comprehensive ownership policy, corporate governance, prioritization for restructuring, specific measures to restructure large SOEs, and propose transparent privatization of identified assets in the medium run; examine options for improving management of other state assets such as real estate. - In preparation, Ministry of Economy with Ministry of Finance and line ministries will: - Corporate governance: By end-May 2015, (i) prepare an inventory of all legislation governing the SOE sector related to regulatory, ownership and oversight policies; (ii) develop a reform plan to consolidate the existing legislative framework and specify the preferred option for separation of government’s regulatory and SOE ownership functions; (iii) articulate main measures to improve corporate governance standards by adopting international standards. - Financial viability: - By end-March, prepare an inventory of at least the 50 largest (in terms of assets or losses) SOEs specifying: (a) turnover, sales, revenues, expenses, assets and liabilities, arrears, including wage arrears, number of employees, average salary; (b) subsidies and other transfers from the government, dividends paid to the budget, government guarantees issued and other contingent liabilities; and (c) legal status and functions, including corporate status. - By end-July, extend coverage to all other SOEs and categorize them in terms of commercial and non-commercial status, and economic viability. - Restructuring plans: By end-April, identify available options for SOEs restructuring and set out a preliminary list of 30 key SOEs that may be subject to restructuring on a priority basis. - Communication: prepare a communications strategy on government’s proposals for reform of the SOE sector. - Inventory of state property: - By end-August, prepare an inventory of real estate owned by the central government (Ministry of Economy in cooperation with line ministries and the State Property Fund). - Transparency: - By end June, Ministry of Economy will propose and begin implementation of key transparency policies to publish details of value, yield and size of the portfolio, including: - creation and management of a public database with historic and current information on the financial performance of the 50 largest SOEs; - preparation and publication of a comprehensive report on SOEs operating and financial performance, forming the basis for expanding the database to all SOEs and subsequent publication of annual reports on SOE performance. *Source: _cr1569 - 29. Eliminating energy subsidies requires an effective strategy for protecting lower-* ### 37. We will ensure that adequate safeguards are in place. An IMF safeguards assessment ### _cr1569 - 37. We will ensure that adequate safeguards are in place. An IMF safeguards assessment ### Safeguards assessment and overall response - An IMF safeguards assessment completed in August 2014 made recommendations to improve NBU governance, financial autonomy, and internal controls. - These recommendations have been or are being addressed in the context of the proposed program. ### NBU governance and autonomy - Draft legislative amendments to the NBU Law (described in ¶9) will address the legislative issues flagged in the safeguards assessment. - Draft legislative amendments to the Budget Code will block the annual budget from requiring advance NBU profit distributions. ### NBU internal controls - In May 2014, the government and the NBU signed an Agreement concerning the servicing of future financial obligations related to the budget support under the current program and provided a copy of this Agreement to the IMF. - Quarterly data audits, first introduced during the 2008 IMF-supported program, have been resumed; results will be communicated to the IMF within six weeks of each test date. - The NBU will establish a permanent senior level credit committee by the first review of the program; the committee will oversee the NBU’s lending operations, including emergency liquidity assistance. - The NBU will shift the origination and management of these operations to a function outside of banking supervision. ### Program monitoring framework - Implementation will be monitored through prior actions, quarterly reviews, quantitative performance criteria and indicative targets, continuous performance criteria, and structural benchmarks. - Review schedule anticipated: - First review: mid-June 2015 (based on end-March 2015 quantitative targets and relevant structural benchmarks). - Subsequent reviews: mid-September 2015; mid-December 2015; mid-March 2016. - For all reviews, quantitative performance criteria will include: - a ceiling on the cash deficit of the general government; - a ceiling on the combined deficits of the general government and Naftogaz; - a ceiling on publicly guaranteed debt; - a floor on cumulative change in the NIR; - a ceiling on cumulative change in the NBU’s NDA; - non-accumulation of external debt payments arrears by the general government. - Understandings and specifications are further detailed in the Technical Memorandum of Understanding (TMU) attached to the memorandum. ### Selected prior actions and structural benchmarks (high-level) - Financial Sector: - Parliament will approve legislation introducing unlimited liability of bank owners on losses from loans benefiting bank shareholders holding 10 percent or more as of end-2014 (¶13). - Energy Sector (examples): - Energy regulator to adopt and publish decision to raise household gas prices to UAH 3600/tcm for Tier 1 and UAH 7187/tcm for Tier 2, effective April 1, 2015 (¶28). - Energy regulator to adopt and publish decision to raise household heating prices to UAH 625/gcal on average, effective April 1, 2015 (¶28). - Cabinet to submit to Parliament legislative amendments to improve Naftogaz collections including lifting moratoria (Law 2711-IV/2005 and Law 2864-III/2001) and disconnecting non-compliant customers (¶28). - Fiscal Policy: - Parliament will approve a 2015 supplementary state budget law and tax/expenditure legislation consistent with the program deficit ceiling of UAH 78 billion for the general government (¶23). - Government will hire financial and legal advisors for consultations with holders of public sector debt (Done February 11, 2015). - Governance: - Parliament will approve legal amendments to ensure the NAB is subject to robust external oversight and other measures (Done February 25, 2015). - Structural benchmarks include timelines for: approval of amendments to the NBU Law (End-April 2015); NBU notifications and reductions related to related party exposure (End-July 2015 through 2016 schedule); selective increase of court fees (End-May 2015); laws strengthening Code of Civil Procedure provisions (End-August 2015); revenue administration reform plan (End-April 2015); SOE fiscal risk statement (End-April 2015); SOE reform strategy (End-May 2015); establishment of the National Anti-corruption Bureau (End-April 2015); AML framework strengthening (End-June 2015); Naftogaz audit and gas market law (End-June 2015 and End-April 2015 respectively). ### Quantitative performance criteria and indicative targets (selected exact figures) - Table 2 targets (End of period; millions of Ukrainian hryvnias, unless otherwise indicated). Data for December 2014 are stocks as of end-December, 2014. Targets and projections are cumulative flows from January 1, 2015. - I. Quantitative performance criteria (stocks/flows) - Ceiling on the cash deficit of the general government (- implies a surplus): - December 2014: - - March (PC): 20,400 - June (PC): 32,700 - September (IT): 40,700 - December (IT): 78,200 - Ceiling on the cash deficit of the general government and Naftogaz (- implies a surplus): - December 2014: - - March (PC): 36,500 - June (PC): 62,000 - September (IT): 94,700 - December (IT): 136,200 - Floor on cumulative change in net international reserves (in millions of U.S. dollars) 2/ 3/: - December 2014: 1,827 - March (PC): -2,502 - June (PC): -1,448 - September (IT): -511 - December (IT): 2,291 - Ceiling on cumulative change in net domestic assets of the NBU 2/ 3/: - December 2014: 304,385 - March (PC): 57,704 - June (PC): 76,176 - September (IT): 88,146 - December (IT): 54,671 - Ceiling on publicly guaranteed debt: - December 2014: - - March (PC): 30,000 - June (PC): 30,000 - September (IT): 30,000 - December (IT): 30,000 - II. Continuous performance criterion - Non-accumulation of new external debt payments arrears by the general government: - December 2014: 0 - III. Indicative targets (selected) - Ceiling on cumulative change in base money: - December 2014: 333,194 - March (PC): 18,256 - June (PC): 53,350 - September (IT): 80,086 - December (IT): 90,796 - Ceiling on net accumulation of VAT refund arrears: - December 2014: 697 - March (PC): 0000 - IV. Memorandum items (selected) - External project financing: - December 2014: - - March: 4,523 - June: 11,064 - September: 19,287 - December: 25,274 - NBU loans to DGF and operations with Government bonds issued for DGF financing or banks recapitalization: - December 2014: - - March: 25,000 - June: 44,000 - September: 53,000 - December: 55,000 - Government bonds issued for banks recapitalization and DGF financing: - December 2014: 26,716 - March: 29,000 - June: 59,500 - September: 59,500 - December: 139,000 - Programmed disbursements of international assistance except IMF (millions of U.S. dollars): - December 2014: - - March: 476 - June: 3,233 - September: 3,733 - December: 5,461 - Percent of it applied to adjustment: - March: 100 - June: 100 - September: 100 - December: 100 - Purchases of foreign exchange from the NBU for the purposes of critical energy imports (incl. those of Naftogaz, millions of US dollars): - December 2014: - - March: 1,486 - June: 1,686 - September: 1,686 - December: 1,686 - NBU purchases of T-bonds Issued by Government for Naftogaz recapitalization: - December 2014: - - March: 17,200 - June: 26,100 - September: 28,300 - December: 28,300 - Projected Payments of Interest on government bonds held by NBU: - December 2014: - - March: 7,100 - June: 17,400 - September: 27,400 - December: 38,000 - Program exchange rate, Hryvnia per U.S. dollar: - December 2014: 15.7686 - March: 15.7686 - June: 15.7686 - September: 15.7686 - December: 15.7686 ### Reporting, TMU and implementation notes - Definitions and adjustors are specified in the Technical Memorandum of Understanding (TMU). - Targets and projections are cumulative flows from January 1, 2015. Data for December 2014 are stocks as of end-December, 2014. - Calculations using program exchange rates are specified in the TMU. - Quarterly targets are cumulative flows from end-December, 2014 for items such as VAT refund arrears. *Source: _cr1569 - 37. We will ensure that adequate safeguards are in place. An IMF safeguards assessment* ### 15.7686 set by the NBU as of December 31, 2014, and (ii) reference exchange rates of foreign ### _cr1569 - 15.7686 set by the NBU as of December 31, 2014, and (ii) reference exchange rates of foreign ### Program exchange rates and valuation assumptions - Program exchange rates are fixed over the program period and differ from actual market exchange rates. - Specific reference exchange rates (reported by the ECB as of December 31, 2014, and used by the NBU) and other valuation parameters: - Swiss Franc: 0.9904 per dollar - Euro: 1.2141 dollars - Pound Sterling: 1.5587 dollars - Australian dollar: 0.8187 U.S. dollars - Canadian dollar: 0.8633 dollars - Japanese yen: 119.6195 per dollar - Norwegian Krone: 0.1343 dollars - Accounting exchange rate for the SDR: 0.690224 per dollar - Official gold holdings valued at 1,206.00 dollars per fine ounce - Setting a program exchange rate for computing monetary aggregates does not imply an exchange-rate target for policy purposes. ### GDP definition for program purposes - Gross domestic product is compiled as per the System of National Accounts 2008 and excludes Crimea and Sevastopol. ### Net International Reserves (NIR) — definition and components - NIR of the NBU: dollar value of the difference between usable gross international reserve assets and reserve-related liabilities to nonresidents, evaluated at program exchange rates. - Usable gross international reserves comprise readily available claims on nonresidents denominated in convertible foreign currencies, consistent with the Balance of Payments Manual (Fifth Edition) and the SDDS (Table A, item 1). - Exclusions from usable reserves include, inter alia: - any assets denominated in foreign currencies held at, or claims on, domestic institutions; all foreign currency claims of the NBU on domestic banks; NBU deposits held at the Interbank Foreign Currency Exchange Market and domestic banks for trading purposes; - any precious metals or metal deposits, other than monetary gold and gold deposits, held by the NBU; - any assets corresponding to claims of commercial banks in foreign currency on the NBU and any reserve assets that are: (i) encumbered; or (ii) pledged as collateral (insofar as not already included in foreign liabilities, or excluded from reserve assets); or (iii) frozen; - any reserve assets not readily available for intervention in the foreign exchange market because of lack of quality or lack of liquidity that limits marketability at the book price. - Reserve-related liabilities comprise: - all short-term liabilities of the NBU vis-à-vis nonresidents denominated in convertible foreign currencies with an original maturity of one year or less; - the stock of IMF credit outstanding; - the nominal value of all derivative positions (including swaps, options, forwards, and futures) of the NBU and general government, implying the sale of foreign currency or other reserve assets; - all foreign exchange liabilities of the NBU to resident entities (e.g., claims in foreign exchange of domestic banks, and NBU credits in foreign exchange from domestic market) excluding foreign exchange liabilities to the general government, or related to deposit guarantees. ### Table A (components) — accounting references - The technical memorandum maps types of foreign reserve assets and liabilities to NBU balance sheet and memorandum accounts; definitions correspond to the system of accounts in existence on December 31, 2014. - Note: The notional value of derivative commitments is used (not the market value). ### Adjustment mechanism for NIR targets - NIR targets will be adjusted upward (downward) by the full amount of the cumulative excess (shortfall) in program disbursements relative to the baseline projection (Table B). Program disbursements are external disbursements (excluding project financing disbursements) from official multilateral creditors (World Bank, European Commission, European Investment Bank, and EBRD), official bilateral creditors (net), and external bond placements usable for financing the central government budget deficit. - NIR targets will be adjusted upward by the cumulative shortfall in purchases of foreign exchange from the NBU for the purposes of paying critical energy imports (including those of Naftogaz) relative to the baseline projection (Table C). - NIR targets will be adjusted downward by the full amount of the cumulative excess in government purchases of foreign exchange from the NBU for the purpose and in the event of early repayment of the government-guaranteed part of a maturing external loan to Naftogaz; the downward adjustment is capped at US$500 million. - NIR targets will be adjusted upward by the amount converted from Renminbi into US Dollar through an outright sale under an activated swap agreement between the People’s Bank of China and the NBU. ### Table B — Eurobond placements and disbursements from IFIs and official sources (projections for NIR/NDA adjustment) - Cumulative flows from end-December 2014, millions of US dollars at program exchange rate: - End-March 2015: Eurobond placement 0; World Bank 0; EU 304; Others (Canada, Japan, Switzerland, Norway) 173; Total 476 - End-June 2015: Eurobond placement 1,000; World Bank 500; EU 1032; Others 701; Total 3,233 - End-September 2015: Eurobond placement 1,000; World Bank 1,000; EU 1032; Others 701; Total 3,733 - End-December 2015: Eurobond placement 2,000; World Bank 1,000; EU 1,760; Others 701; Total 5,461 ### Table C — Purchases of foreign exchange from NBU for critical energy imports (projections for NIR adjustment) - Cumulative flows from end-December 2014, millions of US$: - End-March 2015: 1,486 - End-June 2015: 1,686 - End-September 2015: 1,686 - End-December 2015: 1,686 ### Net Domestic Assets (NDA) — definition and adjustment rules - NDA of the NBU: difference between the monetary base (as defined in the memorandum) and the NIR of the NBU (valued at the program exchange rate defined in paragraph 3 and expressed in hryvnia). - NDA targets adjustment rules (consistent with NIR adjustment mechanism): - Adjusted downward (upward) by the full amount of the cumulative excess (shortfall) in program disbursements relative to the baseline projection (Table B), evaluated at the program exchange rate. - Adjusted downward by the full amount of the cumulative shortfall in NBU purchases of T-bonds issued by government for Naftogaz recapitalization relative to the baseline projection (Table D). - Adjusted upward by the hryvnia equivalent of the full amount of the cumulative excess in government purchases of foreign exchange from the NBU for repaying the government-guaranteed part of a maturing external loan to Naftogaz (if repaid ahead of schedule), capped at the hryvnia equivalent of US$500 million (calculated using the program exchange rate). - Adjusted upward by the full amount of the cumulative excess in the total amount of NBU loans to the Deposit Guarantee Fund (DGF) as well as total amount of NBU purchases of government bonds issued for purposes of DGF financing, and NBU purchases of government bonds issued for bank recapitalization, relative to the baseline projection, evaluated at the program exchange rate if provided in foreign exchange (Table D). - Symmetric adjustor for swap with People’s Bank of China: NDA targets adjusted upward by the amount of hryvnia placed in a commercial bank’s account at the NBU when the People’s Bank of China uses the hryvnia; adjusted downward by the amount of hryvnia (principal and interest) when the People’s Bank of China repays the used hryvnia. ### Table D — NBU loans to DGF and purchases of government bonds (projections for NDA/monetary base adjustment) - Cumulative flows from end-December 2014, millions of hryvnia: - End-March 2015: NBU loans to DGF and purchases for DGF financing or bank recapitalization 25,000; NBU purchases for Naftogaz recapitalization 17,200 - End-June 2015: 44,000; 26,100 - End-September 2015: 53,000; 28,300 - End-December 2015: 55,000; 28,300 ### Monetary base (indicative target) — definition and adjustment rules - Monetary base comprises domestic currency outside banks and banks' reserves, including cash in vault of commercial banks, and funds of customers at the NBU. - Detailed account compositions: - Currency outside banks: Currency—banknotes and coins—(NBU accounts 3000 (net)+3001 (net)-3007A-3009A-1001A-1004A-1007A-1008A-1009A) minus cash in vault at deposit money banks (DMB accounts 1001A:1005A, and 1007A). - Banks’ reserves: cash in vault at DMBs (DMB accounts 1001A:1005A, and 1007A) plus DMB correspondent account deposits at the NBU in hryvnia (NBU liabilities accounts 3200, 3203, 3204, and 3206) plus funds of customers at the NBU in hryvnia (NBU liabilities accounts of groups 323, 3250, 4731, 4732, 4735, 4736, 4738, 4739, and 4750), plus accrued interest on time deposits of DMBs in national currency (NBU accounts 3208L), plus accrued interest on client’s current accounts in national currency. - Monetary base targets adjustment rules (consistent with NDA mechanism): - Adjusted upward by the full amount of the cumulative excess in total NBU loans to the DGF and total NBU purchases of government bonds issued for DGF financing or bank recapitalization relative to the baseline projection (Table D), evaluated at the program exchange rate if provided in foreign exchange. - Adjusted upward by the amount of hryvnia placed in a commercial bank’s account at the NBU when the People’s Bank of China uses the hryvnia; adjusted downward by the amount of hryvnia (principal and interest) when the People’s Bank of China repays the used hryvnia. ### Cash deficit of the general government — definition - General government comprises the central (state) government (including the Road Fund (UkrAvtoDor)), all local governments, and all extra budgetary funds, including the Pension Fund, Unemployment Fund, and the Fund for Social Insurance of Ukraine. - Budget of the general government comprises: (i) the state budget; (ii) all local government budgets; and (iii), if not already included in (i), the budgets of the extra budgetary funds listed above, as well as any other extra budgetary funds included in the monetary statistics compiled by the NBU. - The cash deficit of the general government is measured by net financing flows as: - total net treasury bill sales (in hryvnias and foreign currency) as measured by the NBU registry of treasury bill sales (net treasury bill sales defined as cumulative total funds realized from sales of treasury bills at the primary auction and government securities issued for recapitalization of banks and SOEs, less cumulative total redemption of principal on treasury bills), excluding bonds issued to recapitalize Naftogaz and other SOEs, banks and DGF; - plus other net domestic banking system credit to general government as measured by monetary statistics provided by the NBU (all non-treasury-bill financing in domestic or foreign currency extended to the general government by banks less the change in all government deposits in the banking system) as well as any other financing extended by entities not reflected by the monetary statistics provided by the NBU; - plus total receipts from privatization received by the State Property Fund and local governments (including change in the stock of refundable participation deposits and net sale of nonfinancial assets); - plus the difference between disbursements and amortization on any bond issued by the general government or the NBU to nonresidents for purposes of financing the deficit of the general government; - plus the difference between disbursements of foreign credits to the general government (including project loans on-lent to public enterprises) and the amortization of foreign credits by the general government (including on-lent project loans); - plus net sales of SDR allocation in the SDR department; - plus the net change in general government deposits in nonresident banks, or other nonresident institutions; - plus net proceeds from any promissory note or other financial instruments issued by the general government. - All flows to/from the budget in foreign currency will be accounted in hryvnias at the official exchange rate established as of the date of the transaction. ### Adjustment mechanism for the ceiling on the cash deficit of the general government - The ceiling is subject to an automatic adjuster based on deviations of external project financing (disbursements from bilateral and multilateral creditors to the consolidated general government for specific project expenditure) from program projections (Table E). Specifically, if cumulative proceeds from external project financing (in hryvnia evaluated at actual exchange rates): - exceed program projections, the ceiling on the consolidated general government deficit will be adjusted upward by 100 percent of the excess in external project financing. - The ceilings at end-March, end-June, end-September, and end-December 2015 are subject to an automatic adjuster corresponding to the full amount of government bonds issued for banks recapitalization and DGF financing, up to a cumulative maximum of UAH 139 billion in 2015. The test date ceilings for 2015 will be adjusted upward by any amount of the UAH 139 billion bank recapitalization and DGF financing ceiling not used in 2015. - The ceiling is subject to an automatic adjuster on the stock of budgetary arrears on social payments (arrears comprised of wages, pensions, and social benefits owed by the Pension Fund, and central or local governments). Budgetary arrears are payments not made thirty days after they are due. Pension Fund arrears exclude unpaid pensions to individuals who resided or continue to reside on territories temporarily outside government control. - The ceiling at all 2015 test dates will be automatically adjusted downward by VAT refund arrears accumulated as defined in Section E from January 1, 2015. - The ceilings at end-March, end-June, end-September, and end-December 2015 are subject to an upward adjustment for the full amount of government repaying the government-guaranteed part of an external loan to Naftogaz, if repaid ahead of schedule and recorded as an above-the-line transaction; the adjustment equals the actually repaid amount in US$ terms capped at US$500 million, recalculated in hryvnia at the actual exchange rate at the time of repayment. ### Table E — External financing of general government projects (adjustment assumption) - Cumulative flows from January 1, 2015, in millions of hryvnia (technical assumption for the adjuster purpose): - End-March 2015: 4,523 - End-June 2015: 11,064 - End-September 2015: 19,287 - End-December 2015: 25,274 *Source: Excerpt from the IMF technical memorandum for the program (content as provided).* ### 12. The ceilings on the cash deficit of the general government at end-March, end-June, end- ### _cr1569 - 12. The ceilings on the cash deficit of the general government at end-March, end-June, end- ### A. Ceiling adjustments for cash deficit of general government (2015) - The ceilings on the cash deficit of the general government at end-March, end-June, end-September, and end-December 2015 are subject to an automatic downward adjuster equal to the full savings on the budgetary interest bill resulting from any restructuring or reprofiling of existing government debt to NBU as of end-2014. - Such savings are determined as the difference between the actual and projected payments on government bonds held by the NBU. - Projected payments of interest on government bonds held by NBU (cumulative flows from January 1, 2015; In billions of hryvnia): - End-March 2015: 7.1 - End-June 2015: 17.4 - End-September 2015: 27.4 - End-December 2015: 38.0 ### B. Ceiling on VAT refund arrears (Indicative Target) - Ceiling on net accumulation of VAT refund arrears is set to UAH 0 billion. - Definition of stock: claims not settled (cash refund, netting out against obligations of taxpayers, payment with a government bond (VAT bond), or an official decision to reject the claim) within a specified time period after the VAT refund claim has been submitted to the State Fiscal Service (SFS). - Time period for settlement in 2015: 74 days. - Stock of VAT refund arrears as of December 31, 2014: UAH 0.697 billion. ### C. Ceiling on cash deficit of the General Government and Naftogaz (Performance Criterion) — Definition and measurement - The cash deficit of the General Government and Naftogaz = cash deficit of the General Government (as defined elsewhere) + cash deficit of Naftogaz. - Naftogaz defined as the national joint stock company “Naftogaz of Ukraine.” - Cash deficit of Naftogaz is measured from below the line as the sum of: - net domestic banking system credit to the company (all financing in either domestic or foreign currency extended to the company by banks less the change in company deposits in the banking system); - the difference between disbursements of private foreign loans to Naftogaz (including private placements) and the amortization of private foreign loans (including private placements); - the difference between disbursements of official foreign credits to Naftogaz (including project loans) and the amortization of official foreign credits (including project loans); - the disbursements of trade credits to import gas; - the difference between disbursements and amortization on any bonds issued by Naftogaz; - the net change in deposits of Naftogaz in nonresident banks, or other nonresident institutions; - net proceeds from any promissory note or other financial instruments issued by Naftogaz; - net receipts from sale of financial assets (including recapitalization or other form of treasury securities issued to Naftogaz, irrespective of their issuance date); - any other forms of financing of the company not identified above. - Currency valuation rule: all flows in foreign currency are accounted in hryvnias at the official exchange rate as of the date of the transaction. When arrears are outstanding as of the test date, the official exchange rate on the test date will apply to their valuation. ### D. Adjustment mechanism for the ceiling on cash deficit of general government and Naftogaz - Ceiling will be adjusted upward by the amount of financing by multilateral institutions and official bilateral creditors disbursed to Naftogaz for investment projects. - Ceiling will be adjusted downward by the net transfers made by Gazprom (advance transit fee). These transfers are measured on a cumulative basis from the beginning of each calendar year. ### E. Ceiling on non-accumulation of new external debt payments arrears by the general government (Continuous Performance Criterion) - External debt payment arrear defined as a payment by the general government not made within seven days after falling due (including grace period, if any). - The performance criterion applies on a continuous basis throughout the program period. ### F. Ceiling on publicly guaranteed debt (Performance Criterion) - Applies to the amount of guarantees issued in 2015 by the central (state) government. - The official exchange rate applies to all non-UAH denominated debt. - New state guarantees in 2015 will amount to no more than UAH 30 billion. - This ceiling excludes guarantees issued by the Ministry of Finance for NBU borrowings from IMF. ### G. Other continuous performance criteria (during Extended Arrangement) - Ukraine will not during the period: - (i) impose or intensify restrictions on the making of payments and transfers for current international transactions; - (ii) introduce or modify multiple currency practices; - (iii) conclude bilateral payments agreements that are inconsistent with Article VIII; - (iv) impose or intensify import restrictions for balance of payments reasons. ### H. Official exchange rate — Determination - The NBU will, on a daily basis, set the official rate calculated as a weighted average of the exchange rates of the interbank market deals on the same day. - To calculate the official exchange rate, all deals concluded on the day will be considered regardless of the settlement date; specifically, tod, tom and spot (T+2) deals will be included. - NBU will make public its official exchange rate by no later than 18:00 of the day, preceding the one for which it is set. ### I. Reporting requirements — National Bank of Ukraine (NBU) (selection of key reporting frequencies and deadlines) - Monthly: - Aggregate balance sheet for the NBU and a consolidated balance sheet for the deposit money banks, no later than the 25th day of the following month. - General information on NBU financing (and refinancing) of banks and operations mopping up liquidity, format agreed with IMF staff. - Net domestic assets data based on monthly balance sheets within three weeks following the end of the month. - Bank-by-bank and by region loans and provisions; deposits; due from banks (by domestic and foreign currency), monthly. - Bank-by-bank cumulative income statements, monthly. - Banking system monitoring indicators, no later than 25 days after the end of the month. - Data on credit to nongovernment units guaranteed by the NBU, no later than 25 days after the end of the month. - Daily: - Stock of net and gross international reserves, at both actual and program exchange rates. - Information on official foreign exchange interventions and results of any foreign exchange auctions. - Balances held in analytical account 2900 and daily holdings of treasury bills at primary market prices. - Information on daily transactions (volumes and yields) on secondary market treasury bills. - Claims on banks provided and liabilities in agreed format. - Daily operational balance sheets of the NBU and commercial banks (standard reporting forms). - Data on foreign exchange export proceeds and obligatory foreign exchange sales; import transactions for goods and services; amounts of foreign exchange transferred from abroad to benefit of physical persons to be paid in cash without opening an account; FX wires from Ukraine abroad for current foreign exchange non-trade transactions; sales and purchases of foreign exchange cash by individuals; implementation summary of T+2 verification system; aggregated data on main currency flows and exchange market transactions including exchange rate. - Foreign assets and liabilities of the overall banking system (excl. NBU); banks’ open FX positions; deposits and loans aggregated broken down by households and legal entities, maturity, and currency. - Bank-by-bank data for the largest 35 banks and aggregate data for Group III and IV banks on cash and cash equivalents, available funds in NBU accounts (excl. reserve requirements), correspondent accounts, deposits, by currency and deposit type. - Aggregated data on main currency flows including government foreign receipts and payments by currencies and currency breakdown of interbank market operations. - Weekly: - Full breakdown of NBU accounts included in net international reserves (also provided monthly no later than the 25th). - Bank-by-bank information on outstanding amount of loans from the NBU, reported by type of lending; include collateral pledged (by bank and loan type, collateral type, haircut and currency); indicate banks under temporary administration or liquidation. - Weekly data on volumes of non-cash foreign exchange purchases on behalf of banks’ clients and banks broken down by reasons (From N 538). - Bi-weekly (two weekly): - Daily data on the total financing (including refinancing) issued by the NBU to commercial banks broken down by types of instrument, maturity (average weighted), interest rate as well as liquidity absorption transactions. - In an agreed format, data for the entire banking sector and bank-by-bank for Group I and Group II banks on total assets and liabilities; risk weighted assets; regulatory and Tier 1 capital; capital adequacy ratios; deposits; insured deposits; related party exposures; loans and claims by borrower type and currency; collateral and provisions; large exposures; refinanced and restructured loans; average interest rates on outstanding loan stock; securities held; mandatory reserve requirement and assets held at NBU; cash in vaults. - Quarterly: - Report on the banking sector financial stability indicators, no later than 30 days after the expiration of the reporting quarter. - Stock of short- and long-term external debt (including arrears) for both public and private sectors, quarterly. - Detailed quarterly balance of payments data in electronic format within 80 days after the end of the quarter. - Data on actual settlement of external obligations (principal and interest, public and private sectors), provided quarterly within 80 days following the end of the quarter. - Every 10 days: - Operational monetary survey of the NBU, including additional information needed to monitor monetary policy and banking sector developments. - Other reporting commitments: - Provide financial statements (income and expenses) for the current and, if available, following year as approved by the NBU’s Council; notify IMF immediately of any update. - Provide the existing report containing two-week projections of cash flows for the 35 largest banks with the same internal frequency. - Report bi-weekly and bank-by-bank the amount by which Group 1 and 2 banks' regulatory capital has been increased and the instrument or means used. - Once a month inform IMF of any regulatory and supervisory measures against banks violating NBU regulations on capital adequacy, liquidity ratio, large exposures, and connected lending, and decisions on declaring a bank problem or insolvent. - Inform IMF staff if the Treasury does not pay interest or principal on domestic government bonds due to the NBU, deposit money banks, or nonbank entities and individuals, providing information on outstanding interest and principal payments. - Inform IMF staff of any changes to reserve requirements for deposit money banks. - Communicate electronically to IMF staff any changes in accounting and valuation principles applicable to balance-sheet data and notify staff before changes to Charts of Accounts and reporting forms of NBU and commercial banks. *Source: Extract from IMF staff report text unit _cr1569 - 12.* ### 55. The NBU Internal Audit Department will continue to provide an assurance report to the ### _cr1569 - 55. The NBU Internal Audit Department will continue to provide an assurance report to the ### A. NBU internal audit, external audit, and portfolio reporting - The NBU Internal Audit Department will provide an assurance report to the Fund, no later than six weeks after each test date, confirming that: - (i) the monetary data are in accordance with program definitions and have been verified and reconciled to accounting records; and - (ii) that there have been no changes to the chart of accounts or valuation methods that would impact the data reporting. - The NBU will provide the Fund with a copy of the annual management letter from the external auditor within six weeks of completion of each audit. This will remain in effect for the duration of the arrangement and for as long as credit remains outstanding. - The NBU will provide the Fund with data on the interest income received from the portfolio of government bonds available at January 19, 2015 on a quarterly basis but no later than 15 days from the end of the reporting period. ### B. Deposit Guarantee Fund (DGF) reporting requirements - Monthly, bank-by-bank reporting to the IMF of: - the amount of pending payments to insured depositors in banks in liquidation; - the amount of resources available in DGF to pay insured depositors in banks in liquidation, reported by type of resource (e.g., cash balance, government bonds etc.). - Monthly reporting to the IMF of: - the amount and type of resources provided to DGF from the MoF during the preceding month; - a 1-year month-by-month forecast of the amount and type of resources expected from MoF; - the amount of government bonds the DGF plans to sell to or repurchase with the NBU; - the amount that DGF expects to pay out to insured depositors in banks in liquidation (reported bank-by-bank). ### C. Ministry of Finance reporting requirements - Monthly consolidated balances (end-month) of other non-general government entities, including SOEs, holding accounts at the Treasury: no later than 25 days after the end of the month. - Treasury to provide (format agreed with IMF staff): - daily operational budget execution indicators; - daily inflow of borrowed funds (by currency of issuance) to the state budget and expenditures related to debt service (interest payments and principals); - weekly balances of Treasury cash flow (outturn and forecast), including data on government foreign exchange deposits; - 10-day basis data on revenue of the state, local government, and consolidated budgets; - monthly data on funds deposited with the Single Treasury Account, registration accounts of entities not included in the state sector, stock of public entities in account #3712 within the Single Treasury Account; - inflow to the State budget from placing Treasury or any other liabilities to households in foreign and domestic currency and their redemption. - Monthly and quarterly treasury reports in electronic form: - monthly: no later than 25 days after the end of the period; - quarterly: no later than 35 days after the end of the period. - Final fiscal accounts at the end of each fiscal year in electronic form: no later than March of the following year. Reports to provide expenditure data by programs and key spending units and by standard functional and economic classifications. Quarterly reports also to contain standard information on budget expenses to cover called government guarantees. - Monthly data on the public wage bill (excluding SOEs) in line with the template agreed with IMF staff. - Monthly reports on borrowing (disbursements, interests and amortization) of UrkAvtoDor in agreed format. - Monthly information on municipal borrowing and amortization of debt in format agreed with IMF staff. - Monthly reporting, no later than 15 days after the end of the month, on the cash deficit of the general government, with details on: - budget execution data for privatization receipts of the state and local governments; - disbursements of external credits (including budget support and project loans for on-lending) to the consolidated budget and amortization of external debt by the consolidated budget; - net domestic borrowing of the general government, including net t-bill issuance, issuance of other government debt instruments, and change in government deposits. - Monthly data on the stock of all budgetary arrears: no later than on the 1st day of the second subsequent month, including separate line items for wages, pensions, social benefits, energy, communal services, and all other arrears on goods and services. Treasury to report monthly data on accounts payable for state and local budgets (economic and functional classification). The Pension Fund will provide monthly reports on net unpaid pensions to individuals who resided or continue to reside in territories temporarily outside government control. - Monthly information, no later than 25 days after the end of each month, on the amounts and terms of all external debt contracted or guaranteed by the central government. - Monthly electronic reporting, no later than 25 days after the end of the month, of: - (a) outstanding stock of domestic and external debt of the state and local budgets (including general and special funds); - (b) standard files planned and actual external debt disbursement, amortization, and interest payments (including general and special funds), broken down in detail by creditor categories as agreed with Fund staff; - (c) report on external debt amortization and interest payments by days and currencies. - Report on accumulation of any budgetary arrears on external and domestic debt service. - Monthly debt (domestic and external) amortization schedules updated on a weekly basis. - Monthly reporting, no later than 25 days after the end of the month, of external and domestic credit to key budgetary spending units and nongovernment units guaranteed by the government, including: - Naftogaz, State Mortgage Institution, Deposit Guarantee Fund and Agrarian Fund; - amount of sovereign guarantees extended by executive resolutions and actually effectuated; total amount of outstanding guarantees and list of their recipients. - Quarterly (no later than 50 days after the end of each quarter; each month in case of the Pension Fund) reporting in electronic form on approved budgets and quarterly operational data (daily for the Pension Fund only) on revenue, expenditures, arrears, and balance sheets of: - the Pension Fund (detailed breakdowns expected); - the Fund for Social Insurance; - Employment Fund (detailed breakdowns expected); - any other extra budgetary funds managed at the state level. - Within-year amendments to budgets of these funds to be reported within a week after approval. - Annual financial statement including final fiscal accounts of those funds: no later than April of the following year. - Semi-annual data on the number of employees of budgetary institutions financed from the central (state) and local budgets, starting from January 2010. After any public sector wage increase, provide an estimate of its costs for the current and two subsequent fiscal years for the state and local government budgets. - Monthly data, no later than 15 days after the end of each month, on the budgetary costs associated with the recapitalization of banks and SOEs, including upfront cash-deficit impact and costs associated with payment of interests. - Monthly data on expenditure plans (ROSPIS) for state budget. - After each amendment of the state budget, provide data on revenue plans (ROSPIS) for state and local budgets. ### D. State Fiscal Service (SFS) reporting requirements - Monthly data, no later than 25 days after the end of the month, on tax arrears inclusive of deferred payments, interest and penalties outstanding, in the following format (columns as provided in source): Beginning Stock; Netting out during month; I. DEFERRALS DURING MONTH; Write-offs (arrears written off during month); Collections of outstanding debt at beginning of month; New Arrears (tax liabilities becoming overdue during month); Ending Stock; Total; Principal; Interest; Penalties. - Quarterly listing, no later than two months after the end of the quarter, of all tax exemptions granted, specifying: - the beneficiary of the exemption provided; - the duration; and - the estimated subsequent revenue loss for the current fiscal year. - Monthly information, no later than 25 days after the end of the month, on VAT refunds in format containing: - (i) beginning stock of refund requests; - (ii) refund requests paid in cash; - (iii) refunds netted out against obligations of the taxpayer; - (iv) denied requests; - (v) new refund requests; - (vi) end-of-period stock of requests; - (vii) stock of VAT refund arrears according to the definition in paragraph 11 (unsettled VAT refund claims submitted to the SFS more than 74 days before the end-of-period). - Monthly reports 1.P0 on actual tax revenue and 1.P6 on tax arrears, no later than 25 days after the end of each month. - Quarterly reporting, no later than 25 days after the end of each quarter, on the number of tax appeals and associated disputed amounts received by the SFS in each reporting period, and the number of internally resolved appeals indicating those resolved in favor of the controlling body, in favor of taxpayer and partial satisfaction. ### E. Ministry of Economy, Ministry of Energy and Coal Industry, Ministry of Housing and Municipal Economy, NURC and NERC - Quarterly information from the Ministry of Economy on actual levels of communal service tariffs in all regions for major services (heating, water supply, sewage and rent) and their level of cost recovery. The Ministry of Economy, the Ministry of Housing and Municipal Economy of Ukraine, and the National Energy Regulatory Commission will provide the methodology underlying tariff calculations for full cost recovery, including heating and gas. - Monthly reporting (no later than the 25th of the following month) in agreed electronic format (“Ukraine: The Financial Position of Gas Sector”), based on inputs from Ministry of Energy and Coal Industry, Ministry of Economy, SFS/SCS, MoF, NERC, and Naftogaz, on financial indicators in the gas and heating sectors including: - prices and volumes of domestically produced (by production entity) and imported (by sources of imports) gas; - sales, tariffs, arrears, payments to the budget, subsidies, and debt. - Naftogaz to provide monthly updated information on the company’s financial liabilities, with a schedule of loan-by-loan interest and principal payments. - Monthly reporting (no later than the 25th of the following month) by the Ministry of Energy and Coal Industry (based on Naftogaz) in electronic form on: - cash flows and deficit of the company, with breakdown of total cash outlays for gas imports from Gazprom by month in a separate table mutually agreed with IMF staff; - domestic gas used by Naftogaz for sales to households, heating utilities, budget institutions, and industries, including gas produced by SC “Ukrgasvydobuvannya,” and OJSC “Ukrnafta.” - the amount of Naftogaz arrears to domestic suppliers including Naftogaz subsidiaries, Ukrtransgas, Ukrgas vydobuvannya, Ukrnafta 90 days after they are due. - the stock of Naftogaz receivables and the amount of receivables paid in prior month. - Weekly reporting of Naftogaz daily market purchases of foreign exchange by the Ministry of Energy and Coal Industry (based on Naftogaz). - Quarterly, no later than 80 days after the end of each quarter, consolidated information from financial statements of 50 largest SOEs (excluding Naftogaz), including: - (a) gross profit/losses; - (b) net financial results; - (c) subsidies received from the budget; - (d) guarantees granted from the budget; - (e) stock of debt, broken down by domestic and foreign; - (f) taxes and dividends paid; - (g) wage arrears; - (h) other payment arrears. - The report will also include information on the number of all SOE (a) making profits, (b) making loss or (c) balanced with aggregated financial results for each of these groups. ### F. State Statistics Service - In case of any revisions of gross domestic product the State Statistics Service will provide to the IMF revised quarterly data on gross domestic product (nominal, real, deflator) and their components (economic activities, expenditure, income), no later than 10 days after any revisions have been made. ### Annex: occupations eligible for early retirement (Law of Ukraine on Pensions) - Occupations allowing early retirement based on the age and the qualified period of service: - Occupations included in Lists 1 and 2 established by the Cabinet of Ministers’ Resolution #36, plus: Tractor drivers; Public transportation drivers; Workers employed in the textile industry; Milkmaids. - Occupations allowing early retirement based on the qualified period of service: - Employees of education; Employees of healthcare; Employees of social security services; Athletes; Artists; Aviation workers. ### Program financing and exceptional access (selected figures from EFF introduction and Table 1) - Authorities request a four-year EFF with access equivalent to SDR 12.348 billion (900 percent of quota) and intention to cancel the existing Stand-by Arrangement (SBA). - Proposed phasing and purchases (Availability Date / SDR mn / Percent of quota / Cumulative percent of quota): - 2015 February/March: 3,546.0 — 258.52 percent — 258.5 - 2015 June: 1,182.1 — 86.23 — 344.6 - 2015 September: 1,182.1 — 86.24 — 430.8 - 2015 December: 1,182.1 — 86.25 — 516.9 - 2016 March: 438.0 — 31.95 — 548.9 - 2016 June: 438.0 — 31.95 — 580.8 - 2016 September: 438.0 — 31.96 — 612.7 - 2016 December: 438.0 — 31.96 — 644.6 - 2017 March: 438.0 — 31.96 — 676.5 - 2017 June: 438.0 — 31.97 — 708.5 - 2017 September: 438.0 — 31.97 — 740.4 - 2017 December: 438.0 — 31.97 — 772.3 - 2018 March: 438.0 — 31.98 — 804.2 - 2018 June: 438.0 — 31.98 — 836.2 - 2018 September: 438.0 — 31.98 — 868.1 - 2018 December: 438.0 — 31.99 — 900.0 - Total: 12,348.0 — 900.0 percent of quota. *Source: _cr1569 - 55. The NBU Internal Audit Department will continue to provide an assurance report to the* ### 2. Ukraine has had an extensive financial relationship with the Fund since becoming a ### _cr1569 - 2. Ukraine has had an extensive financial relationship with the Fund since becoming a ### IMF engagement and past program performance - Ukraine has been a Fund member since September 1992. - GRA credit outstanding to Ukraine currently stands at SDR 3.785 billion (276 percent of quota). - Performance under previous programs has generally been poor: the 2005 ex-post assessment covering 13 years singled out lack of political consensus to pursue market-friendly reforms as the main cause of repeated program failures. - The 2011 and 2013 ex-post evaluations of the 2008 and 2010 SBA programs also cite weak ownership of policies and weak governance as leading to program failure. - The 2008 two-year SBA-supported program went off track after two reviews and was cancelled in mid-2010. - The 2010 29-month SBA-supported program went off-track after completion of one review. - Ukraine has met its obligations to the Fund in a timely fashion. ### Current SBA and purchases under existing program - In April 2014, the Executive Board approved a 24-month SBA with access equivalent to SDR 10.976 billion (800 percent of quota) to support the authorities’ program (restore macroeconomic stability; strengthen economic governance and transparency; lay foundation for strong economic growth). - Fiscal targets under the 2014 program were met with a margin. - The program was derailed after completing the first review largely because escalation of the conflict in Eastern Ukraine materialized. - Progress was made on a number of key structural reforms, although some key pieces of legislation were watered down. - The purchase associated with the completed review brought cumulative purchases under the existing SBA to SDR 2.973 billion (216.7 percent of quota). ### External debt and debt-service dynamics - Total external debt rose sharply following 2014 exchange rate depreciation and economic contraction: - Total external debt-to-GDP increased to almost 102½ percent in 2014, about 16 percentage points higher than its previous peak reached in 2010. - Total external debt is expected to increase further, to 158 percent of GDP in 2015. - Private sector debt is projected to represent more than two-thirds of total external debt in 2015. - External direct public debt as a share of GDP is projected to increase to 50 percent in 2015, from 26¼ percent in 2014. - External debt service: - Ratio of total external debt service to exports of goods and services peaked at 61 percent in 2009, fell to 49½ percent in 2013, then increased to 54⅓ percent in 2014. - In 2015, total external debt service is projected to remain almost at the 2014 level. - In percent of GDP, Ukraine’s total external debt service in 2015 is projected at 39½ percent, of which nearly one-tenth is borne by the public sector. - The burden of private sector debt service will be eased by a variety of voluntary private debt rollovers now under way. ### Public debt outlook - Public debt developments: - Over 2010–2013, public debt-to-GDP ratio was about 40 percent. - Public gross financing needs increased sharply in 2014 due to exchange rate depreciation, quasi-fiscal losses in the energy sector, ongoing conflict, and weak economy. - By end-2015, total public debt is projected to exceed 94 percent of GDP, far higher than projected at the inception of the existing SBA. - This projected 94 percent of GDP is 54 percentage points of GDP above the median public debt at the time of approval of recent exceptional access cases. ### Risks to the Fund from a proposed extended arrangement - Access and exposure: - If all purchases were made as scheduled, Ukraine’s outstanding use of GRA resources would rise from about 276 percent of quota at end-February 2015 to peak at 963 percent of quota at end-2018. - Peak Fund exposure relative to GDP would be 18.2 percent (exceeding all recent exceptional access cases and comparing with nearly 10¾ percent under the 2014 SBA). - As a share of gross international reserves, Fund exposure to Ukraine would peak in 2015 at 77.3 percent. - As a share of total external debt, peak Fund exposure would be 12.8 percent (compared with 11 percent median peak of recent exceptional access cases and peak under Ukraine’s 2014 SBA). - Credit and liquidity implications: - The proposed extended arrangement would reduce Fund liquidity by 1.8 percent. - Taking into account undrawn balances under the 2014 SBA being cancelled, the proposed arrangement would reduce one-year forward commitment capacity (FCC) from SDR 235 billion as of February 20, 2015 to SDR 230.7 billion. - After Ukraine’s first purchase under the proposed arrangement, the Fund’s exposure to the top five borrowers would increase only marginally. - With almost 5.9 percent of GRA credit outstanding, Ukraine is the fourth largest user of GRA credit behind Portugal, Greece, and Ireland; the share of the top five borrowers amounts to 88.6 percent. - After Ukraine’s scheduled first purchase, its share of outstanding GRA credit would increase to 10.6 percent and the share of the top five borrowers would increase to 89.2 percent. - The GRA commitment to Ukraine amounts to 97 percent of the current level of precautionary balances; assuming all purchases as scheduled, Fund exposure to Ukraine as a share of the current level of precautionary balances would rise from 56.7 percent after the first purchase is made to higher values thereafter. ### Role of the debt operation and external financing - The authorities’ intended debt operation could, if successful, help alleviate Ukraine’s debt service burden and mitigate risks to the Fund. - The proposed arrangement has a longer repurchase period relative to the SBA, with large repurchases falling due during 2020–25. - The operation sets an objective to limit gross financing needs during 2020–25, which should help mitigate risks to the Fund. - Despite expected unlocking of assistance from other official donors and the private sector, the Fund would remain the largest official creditor: - Since 2008, by credit outstanding, the Fund has been the top official creditor to Ukraine’s government, with an average share of 54 percent during 2008–14. - At end-2014, the share of outstanding Fund credit to Ukraine in total official lending to Ukraine stood at 36 percent. - During 2015–18, projected Fund financing under the proposed arrangement represents 44 percent of total financing to Ukraine from all its creditors and 70 percent of new official disbursements. - Debt service to the Fund will be high after the end of the proposed arrangement, averaging 59 percent of total public external service during 2018–24 and peaking at over 80 percent. - The high Fund exposure underscores the role non-Fund external finance should play during the program period and beyond to mitigate risks to the Fund. ### Key numeric indicators and projections (selected) - Current GRA credit outstanding: SDR 3.785 billion (276 percent of quota). - 2014 SBA access: SDR 10.976 billion (800 percent of quota). - Cumulative purchases under the existing SBA after completed review: SDR 2.973 billion (216.7 percent of quota). - Total external debt-to-GDP: almost 102½ percent in 2014; projected 158 percent in 2015. - External direct public debt as a share of GDP: projected 50 percent in 2015, from 26¼ percent in 2014. - Total external debt service in 2015 (projected): 39½ percent of GDP. - Projected peak Fund exposure relative to GDP: 18.2 percent. - Projected peak Fund exposure as share of gross international reserves in 2015: 77.3 percent. - One-year forward commitment capacity (FCC): SDR 235 billion (Feb 20, 2015) reduced to SDR 230.7 billion under proposed arrangement (including cancellation of undrawn 2014 SBA balances). - Fund’s share of total financing to Ukraine during 2015–18 under proposed arrangement: 44 percent of total financing and 70 percent of new official disbursements. - Projected total public debt by end-2015: exceed 94 percent of GDP. *Source: IMF staff report (excerpted)._ ### 92.8 percent in 2016 and would peak at 103.7 percent in 2018. ### _cr1569 - 92.8 percent in 2016 and would peak at 103.7 percent in 2018. ### Impact on GRA finances and liquidity - Ukraine’s public debt path: "92.8 percent in 2016 and would peak at 103.7 percent in 2018." - Charges and Fund burden-sharing capacity: - Charges for Ukraine projected at SDR 141.8 million for the remainder of 2015. - Charges projected to average SDR 328 million a year over 2016-2019. - The Fund’s residual burden-sharing capacity: 0.7 (memorandum item). - Ukraine's annual GRA charges in percent of Fund's residual burden sharing capacity for 2014: 22,446.2 - Liquidity and FCC (as of 2/20/2015): - Current one-year Forward Commitment Capacity (FCC) 1/: 235,023.3 (millions of SDR). - Impact on FCC on approval 2/: -4,344.7 (millions of SDR). - (in percent of current one-year FCC): -1.8 - Prudential measures and credit concentration: - Fund GRA credit outstanding to Ukraine 3/: 7,206.2 (millions of SDR). - In percent of current precautionary balances 4/: 56.6 - In percent of total GRA credit outstanding: 11.2 - Fund GRA credit outstanding to top five borrowers — In percent of total GRA credit outstanding: 88.6 - In percent of total GRA credit outstanding including Ukraine's first post-augmentation purchase: 89.2 - Fund's precautionary balances (FY 2014): 12,730 (millions of SDR). ### Assessment — program risks and conditions for success - Overall judgment: - "The program faces exceptionally high risks." - Debt trajectory sensitive to fiscal adjustment, economic growth, and the exchange rate path. - Key conditions for program success (critical policy priorities): - "A decisive and sustained break with the record of generally poor policy implementation under previous programs and a strong political resolve to tackle vested interests." - "A successful debt operation that would alleviate the debt service burden, ensure that the program is sufficiently financed, and promote debt sustainability." - "The effective restructuring of the banking sector and the unwinding of systemic related party lending without excessively constraining credit to the private sector." - "A relatively rapid and decisive reorientation of economic activity and external trade to make up for severe disruptions in trade with Russia." - "Regaining meaningful market access by the end of the program." - Specific downside scenarios and risks: - Failure to restore the financial health of Naftogaz would undermine fiscal adjustment, market confidence, and trigger exchange rate pressures; increases in end-user prices may not yield expected revenues owing to higher unemployment, falling real wages, and a depreciating exchange rate. - An unsuccessful debt operation could undermine public debt sustainability, exacerbate the confidence crisis, disrupt private sector debt restructuring, reduce availability of foreign exchange, and undermine prospects to regain market access by end-2017. - A less favorable macroeconomic framework (policy slippages, subdued exports and growth, more depreciated exchange rate) would "seriously lower the probability of putting debt on a sustainable path." - Policy implication: - "Strict adherence to the program will be critical." - If a major shock materializes, "the willingness of Ukraine’s other official creditors to provide concessional financing would be critical." ### Recent developments (early March 2015): exchange market stress and policy response - Exchange rate episode: - Hryvnia depreciated to around UAH 24–25/US$1 in early February 2015. - Sharp depreciation by over 20 percent during February 18–25. - Monetary and FX market measures taken: - NBU increased its main policy rate (the discount rate) by 1050 basis points to 30 percent. - All interest rates on central bank facilities were increased accordingly. - Extension of controls on FX demand, including measures mainly affecting imports. - Bank lending in hryvnia for purchase of FX was banned. - Banks’ daily FX purchases on the interbank market limited to 0.1 percent of their regulatory capital as of the previous day. - Administrative measures on all FX transactions, including stricter requirements (e.g., certificate of being current on tax payments) for FX purchase and transfers; no lending in hryvnia against FX deposit collateral; expansion of the verification procedure to "T+3" for FX transfers abroad made out of own FX funds. - Additional measures to reduce capital flight: broadened verification measures to limit under-invoicing of exports; ban on transfer of proceeds from non-debt securities traded in the stock exchanges. - Market impact: - Combination of intensified controls and monetary tightening "appears to have eased pressures in the interbank foreign exchange market." - NBU bought over US$400 million following measures. - Authorities planned to lift administrative measures once BOP and financial conditions strengthen and prepared a plan for eventual and gradual removal (MEFP ¶8). ### Banking sector, fiscal and legislative actions - Banking sector resolution: - Three additional banks declared insolvent and put under the Deposit Guarantee Fund’s temporary administration, bringing total banks resolved to 44. - This included the fourth largest bank, representing 4 percent of assets and 4½ percent of deposits. - Parliamentary and regulatory actions: - Legislative amendments on improving Naftogaz collections submitted to parliament. - On March 2, parliament approved a revised state budget and a package of tax and expenditure legislations consistent with program targets. - Parliament approved legislation introducing unlimited liability of bank owners on related party loans. - On March 3–4, the energy regulator adopted decisions to raise gas and heating prices, effective April 1. ### Staff appraisal and program outlook - Staff view: - "Tighter monetary policy and enhanced administrative controls were necessary and appropriate to prevent an exchange rate overshooting." - Quick action demonstrates commitment to macroeconomic stabilization. - "Staff does not see a need to update the program’s macroeconomic framework and program objectives remain attainable." - The exchange rate overshooting "lasted for a few days and should not have a lasting impact on inflation or the economy." - If measures are unwound as balance of payments improves (including external official financing), impact on economic activity in 2016 and beyond should be limited. - The macroeconomic framework will be revisited during program reviews. ### Exchange system measures — jurisdictional assessment (measures giving rise to Article VIII issues) - Measures determined to give rise to exchange restrictions under Article VIII, Section 2(a), and multiple currency practices under Article VIII, Section 3: - Exchange restriction: absolute limits on availability of foreign exchange for certain non-trade current international transactions (NBU Resolution 160, adopted March 3, 2015): - Monthly cap for certain individual non-trade transfers abroad from foreign exchange accounts: UAH 150,000 with supporting documents. - Daily cap if effected by residents without supporting documents or without opening a foreign exchange account: UAH 15,000 daily. - Exchange restriction: ban on transfer abroad of dividends received by nonresident investors from foreign investments in Ukraine (NBU Resolution 160, dated March 3, 2015). Scope extended in March 2015 to cover dividends from exchange traded securities. - Exchange restriction: requirement to provide a tax clearance certificate evidencing payment of all taxes before authorization for import payments equal to or exceeding US$50,000 (NBU Resolution 160, dated March 3, 2015). - Multiple currency practice: use of multiple price foreign exchange auctions conducted by the NBU without a mechanism to prevent (i) a spread deviation of more than 2 percent in the exchange rates at which the NBU sells foreign exchange to successful bidders; and (ii) a spread deviation of more than 2 percent between the auction rates and the market exchange rate. - Existing multiple currency practices continued (subject to Fund approval under Article VIII, Section 3): - Requirement to transfer the positive difference between the sale and purchase price of foreign exchange to the state budget if the purchased foreign exchange is not used within 10 days and is resold. - Use of the official exchange rate for government transactions, including transactions of some SOEs, without establishing a mechanism to ensure official exchange rate does not deviate from the market exchange rate by more than 2 percent. *Prepared by The European Department; Supplement and staff assessments as provided in the source document.* ### 4. The authorities have requested Fund approval for the retention of all the ### _cr1569 - 4. The authorities have requested Fund approval for the retention of all the ### Request and Fund decision - The authorities have requested Fund approval for the retention of all the exchange restrictions and multiple currency practices. - The authorities committed to prepare by mid-May 2015 a plan for the removal of all these measures as soon as conditions permit. - Staff supports Executive Board approval as the measures are temporary, for balance of payments reasons, and non-discriminatory. - A decision is proposed for consideration of the Executive Board. ### IMF Executive Board action and program summary - The Executive Board approved a four-year extended arrangement under the Extended Fund Facility (EFF) for Ukraine amounting to the equivalent of SDR 12.348 billion (about US$17.5 billion, 900 percent of quota). - The Board approved the arrangement under the Fund's exceptional access policy and noted Ukraine’s decision to cancel the Stand-By Arrangement (SBA) approved on April 30, 2014. - The approval enables the immediate disbursement of SDR 3.546 billion (about US$5 billion), with SDR 1.915 billion (about US$2.7 billion) allocated to budget support. - Further disbursements will be based on standard quarterly reviews and performance criteria. - Program aims: put the economy on the path to recovery, restore external sustainability, strengthen public finances, support economic growth via structural and governance reforms, and protect the most vulnerable. ### Key policy pillars and measures - Securing financial stability: - Strong monetary policy framework to restore price stability. - Exchange rate flexibility to cushion against external shocks. - Comprehensive banking strategy: bank recapitalization, reduction of related party lending, resolution of impaired assets. - Strengthening public finances: - Expenditure-led adjustment to support fiscal consolidation. - Energy sector reforms and announced debt operation to reduce fiscal imbalances and achieve public debt sustainability with high probability. - Revamp social protection schemes to protect the poorest. - Advancing structural reforms: - Governance reforms including anti-corruption and judicial measures. - Deregulation and tax administration reforms. - Reforms of state-owned enterprises to improve corporate governance and reduce fiscal risks. - Naftogaz restructuring and broader energy sector reforms to increase energy efficiency and foster energy independence. ### Macroeconomic outlook and projections - Short-term (2015): - Real GDP is expected to contract by about 5½ percent in 2015. - Inflation is expected to spike temporarily and subsides to about 27 percent at end-2015. - Current account deficit should fall to about 1½ percent of GDP. - Gross international reserves will be gradually re-built, reaching around 3.3 month of imports coverage at end-2015. - Public sector debt is expected to rise to 94 percent of GDP in 2015. - External debt is expected to rise to 158 percent of GDP in 2015. - Medium-term (2016–2020): - Real GDP growth expected to rebound to 2 percent in 2016 and rise to 4 percent in the medium term. - Current account deficit projected to stabilize at around 1¼ percent of GDP in 2016–18. - By end-2018, inflation will fall to mid-single digits and the NBU will build international reserves to cover nearly 83 percent of short term debt. - Following the debt operation and sustained fiscal adjustment, public debt is expected to decline to around 71 percent of GDP by 2020. ### Recent economic developments and shocks (selected figures) - GDP contraction in 2014 is estimated at 6.9 percent. - Industrial output fell by 10.1 percent; construction by 21.7 percent; retail by 8.6 percent; wholesale trade by 15 percent. - Agriculture output increased by 2.8 percent due to a record high harvest of cereals. - Current account deficit in 2014: US$6.1 bln, or 4.8 percent of GDP. - Imports fell by 27.4 percent in 2014; exports declined by 14.4 percent. - Net capital outflow reached US$8.1 bln in 2014. - Aggregate capital adequacy ratio dropped below 14 percent in early February 2015 from 16 percent six months earlier. - Year-on-year headline inflation: 28.5 percent in January 2015; y-o-y core inflation: 26.1 percent. - Fuel prices increased by 60 percent y-o-y despite decline in oil prices. - In one week in February 2015 the exchange rate depreciated by about 20 percent; on March 6, 2015 the exchange rate appreciated to 22.5–23 Hryvnia/US$. ### Monetary, exchange rate, and FX measures - Authorities committed to a flexible exchange rate regime; foreign exchange restrictions and capital controls to be removed gradually when circumstances allow. - Monetary policy aims for low and stable inflation with inflation targeting to be adopted when conditions allow. - Structural benchmark: Amendments to the NBU Law to be adopted by the end of April (structural benchmark). - Planned institutional changes: downsizing NBU Board from 11 to 6 members and establishment of a Monetary Policy Committee. - NBU actions in February–March 2015 (in close consultation with the IMF): - Main policy rate increased from 19.5 to 30 percent. - NBU’s refinance and deposit rates increased accordingly, by 1050 basis points. - Temporary administrative FX measures: extended verification procedures, verification threshold reduced to US$50,000, verification period prolonged to three days, prohibition on Hryvnia lending for FX purchase, significant limits on banks’ FX non-cash purchases on their own behalf. - Tightened verification requirements for all FX transactions. ### Financial sector actions - 2014 diagnostic led to specific recapitalization and resolution plans for several banks. - Deposit Guarantee Fund (DGF) framework enhanced: legal and operational capability to resolve banks and to issue and operate with own and governments’ securities to cover gaps between assets and liabilities transferred from insolvent to solvent institutions (prior action completed in September 2014). - On March 2, 2015, parliament approved legislation holding bank owners responsible for losses on loans granted to shareholders holding 10 percent or more of total voting shares (prior action). - Banks required to submit reports of related exposure; credible action plans required. ### Fiscal policy developments and measures - 2014 general government fiscal deficit target was met despite difficult circumstances. - 2015 budget (adopted December 2014) includes broad revenue and expenditure measures: widen tax base, eliminate massive exemptions, abolish distortive taxes, simplify rules, introduce new excises and a tax on luxury vehicles, increase tobacco excises, royalties on natural resources, and personal income tax, and adopt a temporary import duty surcharge for balance of payments reasons. - Nominal wages frozen at 2014 levels (except for military personnel); indexation of minimum pensions delayed until December 2015. - Subsidies to state-owned enterprises reduced; explicit subsidies now means-tested and income-based. - Civil service reduced by around 25,000 since start of the SBA. - On March 2, 2015, parliament approved supplementary measures to the 2015 budget (a prior action): increase revenues by Hryvnia 22.5 bln and increase expenditures by Hryvnia 35.7 bln, widening the budget deficit from 3.7 percent of GDP to 4.2 percent of GDP. This widening is mainly due to increased debt service after the Hryvnia depreciation; reduced support for Naftogaz and the pension Fund will lower the quasi fiscal deficit. ### Implementation risks and conditionality - Program subject to exceptional risks, especially from the conflict in the East, which may affect implementation of stabilization efforts and structural overhaul. - Implementation risks mitigated by: prior actions already adopted, securing broad political support, and expected sizable international official assistance and private capital inflows. - A successful debt operation with high participation will be a key consideration to proceed with the first program review. *IMF Press Release No. 15/107 and accompanying annex, March 11, 2015.* ### 10.5 percent last year to 7.3 percent of GDP this year. As part of these amendments, the ### _cr1569 - 10.5 percent last year to 7.3 percent of GDP this year. As part of these amendments, the ### Fiscal consolidation and budget measures - Budget-paid employees will be reduced by 3 percent in 2015, including a 20 percent decrease of the civil service workforce. - Pension sector saving measures: - Retirement age is being gradually increased by five years for women and a number of professions which were eligible for early retirement. - Benefits for pensioners who continue working are reduced. - Special pensions will be abolished. - Energy-sector fiscal measures: - Increases in rental payments by the state gas companies will fund increased subsidies for the poorest people affected by the increase in energy tariffs. - Medium-term objectives: - Gradual expenditure-based fiscal consolidation. - Strengthening of fiscal institutions with focus on improving tax collection and tax administration. - Strengthening expenditure transparency and control, particularly in government procurement. ### Energy policy and reforms - Tariff and pricing actions taken: - Gas price and heating tariffs for households were raised in May and July 2014. - A new targeted social safety net compensating the poorest for energy price hikes became operational. - Fiscal outcome and drivers: - Depreciation of the exchange rate, reduced gas transit revenues, and a prepayment for imported gas for 2015 led to a deficit of 5.7 percent of GDP instead of 4.3 percent of GDP projected at the time of the first review of the SBA. - Prior action (March 3, 2015 energy regulator resolution): - Gas price increase of 285 percent from April 1, 2015 onwards. - Heating price increase of 67 percent from April 1, 2015 onwards. - Measures to improve gas payment collection. - Legislative and structural reforms: - A new law on the gas market is under preparation to enable third party access to the gas infrastructure and the operation of an energy regulator, and to pave the way for further Naftogaz restructuring. - Further reforms focus on reducing fiscal subsidies, increasing the efficiency of Naftogaz and eliminating its deficit by 2017. - Gradual but persistent increases in retail gas prices and heating tariffs will be accompanied by further social assistance measures to mitigate the impact on low-income households. - Energy efficiency will be pursued. - In cooperation with the World Bank, plans are being finalized to reform the gas sector including splitting Naftogaz’s main activities as extracting, transportation, storage and sales. ### Structural reforms - Business climate improvements: - In collaboration with the World Bank, a law on investors’ protection was prepared to be submitted to parliament by the end of March 2015. - Parliament adopted a new law on transparency of state procurement and a moratorium on inspections. - The number of permits required for business registration was cut from 143 to 85 and the process to get a permit was streamlined. - A business ombudsman was appointed in December 2014. - Anti-corruption and governance measures: - An anti-corruption investigation agency was established in 2014. - Recommendations of the diagnostic study on governance from July 2014 will be gradually implemented. - Authorities are working towards establishing the National Anti-corruption Bureau (NAB) by end-April 2015. - The NAB Law will be amended to strengthen its external oversight, give it power to investigate former Presidents and ensure it has access to all relevant information. - Anti-money laundering efforts are stepped-up by enhancing Ukraine’s AML framework. - Asset disclosure of high-level officials will be enhanced. ### Final remarks and program context - Implementing the ambitious reform agenda in the current challenging context is very demanding and requires extraordinary political determination. - The extended arrangement will provide Ukraine with the necessary breathing space to continue implementing the policies required to meet the program objectives and make progress towards stability and growth. - The staff report quotes Prime Minister Jatsenyuk to demonstrate strong ownership of the program for reforms. - The authorities are committed to take additional measures that may be needed to meet the program objectives. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1569.pdf* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1569.pdf_